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“This is a very thoughtful and an insightful book by Murali Patibandla, which ﬁlls
up a big void in blending business management, international perspectives, global
marketing from an interdisciplinary context. A must read for professionals and a
must textbook for business students who want to have a global vision. An excellent
book.”
Bala Balachandran
J. L. Kellogg Distinguished Professor
Kellogg School of Management
Northwestern University
“Patibandla provides an insightful analysis of how economic reforms are trans-
forming ﬁrms and industries in India. A most worthwhile read for anyone inter-
ested in the institutional foundations of development.”
Amar Bhidé
Lawrence D. Glaubinger Professor of Business
Columbia University
Author of The Origin of Evolution of New Businesses

Evolution of Markets and Institutions
The rich and growing ﬁeld of the new institutional economics has been
one of the most inﬂuential schools of thought to emerge in the past
quarter-century. Taking its roots in the transaction cost theory of the ﬁrm
as an economic organization rather than purely a production function, it
has been developed further by scholars such as Oliver Williamson,
Douglas North and their followers. This branch of economics stresses the
importance of institutions in the functioning of free markets, which
include elaborately deﬁned and effectively enforced property rights in the
presence of transaction costs, large corporate organizations with agency
and hierarchical controls, formal contracts, bankruptcy laws, and regula-
tory institutions. In this timely volume, Murali Patibandla applies some of
the precepts of the new institutional economics to India – one of the
world’s most promising economies.
Murali Patibandlais Professor of Economics and Corporate Strategy at the
Indian Institute of Management Bangalore, India. Prior to this, he was a
faculty member of the Copenhagen Business School, Denmark, the Indian
Institute of Management, Ahmedabad, India and the Fulbright Scholar at
the University of California, Berkeley. He has published extensively in the
areas of international economics, applied industrial organization, develop-
ment and the new institutional economics in journals such as World Devel-
opment, the Journal of Economic Behavior and Organization, the Journal of
Development Studies, the Review of Applied Economics, the International Journal
of Management and Decision Making,Economic and Political Weekly, the Indian
Economic JournalandIIMB Management Review. He serves on the editorial
board of Industry and Innovation.

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27 Labour Relations in
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Beyond conditionality
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30 Competitiveness Strategy in
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A manual for policy analysis
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31 The African Manufacturing
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Dipak Mazumdar and
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Poverty in Asian Developing
Countries
Edited by Kishor Sharma
33 International Competitiveness,
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34 The Pattern of Aid Giving
The impact of good
governance on development
assistance
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35 New International Poverty
Reduction Strategies
Edited by Jean-Pierre Cling,
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Goals
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Theory and evidence
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46 Trade, Growth and Inequality
in the Era of Globalization
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47 Microﬁnance
Perils and prospects
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48 The IMF, World Bank and
Policy Reform
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49 Managing Development
Globalization, economic
restructuring and social policy
Edited by Junji Nakagawa
50 Who Gains from Free Trade?
Export-led growth, inequality
and poverty in Latin America
Edited by Rob Vos,
Enrique Ganuza, Samuel Morley
and Sherman Robinson
51 Evolution of Markets and
Institutions
A study of an emerging
economy
Murali Patibandla

Evolution of Markets
and Institutions
A study of an emerging economy
Murali Patibandla

First published 2006
by Routledge
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© 2006 Murali Patibandla
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This edition published in the Taylor & Francis e-Library, 2006.
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To my mother,
Indira Devi,
Who, when I was very young, said
I should ﬁnd my own way in this world.
I chose my journeys to make their paths.

Contents
List of ﬁgures xii
List of tables xiii
Preface xiv
Abbreviations xvi
1 Introduction 1
2 The conceptual framework 21
3 Initial conditions and economic policy reforms 48
4 The direction of structural changes 88
5 Competitive dynamics 126
6 Technological change 157
7 Organizational change 204
8 The evolution of public and private order institutions 249
9 Conclusion 284
Appendices 294
Notes 305
References 317
Index 330

Figures
Figure 1 Trade policy and distributional outcome: partial
equilibrium 76
Figure 2 Markets and technology adoption 78
Figure 3 The software industry cluster – Bangalore 192
Figure 4 Air Deccan Organization 229
Figure 5 Some indicators of post-reform India 242

Tables
Table 1 Index of economic freedom 17
Table 2 Percentage share of three major sectors in
employment and GDP 66
Table 3 Transaction costs of the Inspector Raj in May 2000 93
Table 4 Performance of the Indian economy, 1970–2001 94
Table 5 Comparative proﬁle of ﬁnancial intermediaries and
markets in India 100
Table 6 Performance of organized manufacturing sector:
some selected indicators, 1980–1 to 2000–1 102
Table 7 Foreign direct investment and trade in India 103
Table 8 Growth rates and sectoral shares of the service industry 108–9
Table 9 Convergence: motorcycle industry – Bajaj Auto and
Hero Honda 135
Table 10 Auto-component production and exports: India 145
Table 11 Industry-wise breakdown of foreign collaboration
approvals in India 168
Table 12 R&D expenditure by the large Indian companies 169
Table 13 Sample of acquiring ﬁrms involved in the M&As
process between 1995 and 2000 219
Table 14 Annual average growth rate of vertical integration,
1990–9 – a sample of commodity and manufacturing
industries 222
Table 15 Institutions for effective tax administration 278
Table 16 The industry list 294
Table 17 Firm-level data 297
Table 18 Econometric explanation of market shares 298
Table 19 Industries with decline in annual average growth rate in
vertical integration, 1990–9 303
Table 20 Industries with increase in annual average growth rate
in vertical integration, 1990–9 304

Preface
“One life, many stories” is what a common man may say about making a
living by dealing with institutions at different levels in India. My interest in
the new institutional economics originated from my struggles as a doctoral
student and a participant in the labor markets in India during the late
1980s and the early 1990s. Around the same time, India embarked on a
program of policy reforms towards a liberal market economy. I submitted
my doctoral thesis in economics to one of the leading universities in India,
Jawaharlal Nehru University (JNU), in January 1991, and had to wait
almost four years to get the degree. The university sent the thesis to two
external examiners in India. One of the examiners gave the evaluation
reports promptly within three months, while the other refused to send the
report for three years, despite numerous reminders from the university.
During this period, I did not have a job. Our daughter Pratyusha was born
in February 1992. As I could not afford to support the family, I had to
leave them at my wife’s parents’ home in Hyderabad in the south. Barely
surviving with borrowed funds, I had to make numerous thirty-hour train
trips from Hyderabad to New Delhi, stay in cheap motels, and run around
the university ofﬁcials, pleading with them to do something. They would
say that the best they could do was to send reminders to the examiner,
and the examiner did not care to reply. In the labor market, I attended a
few job interviews, for which I had to incur high transaction costs. In
several instances, the experience of the interview process was humiliating
because they were basically a farce, with insider trading. I felt that there
was something drastically wrong with the way the free market mechanism
was understood and propagated in several circles in India. If people in
powerful and responsible positions could break contracts and impose
high transaction costs on common people with impunity, there was some-
thing drastically wrong with the institutions. With these kinds of institu-
tional conditions, the free market mechanism would be a highly distorted
process. My interest in the new institutional economics (NIE) began to
germinate.
In October 1993, I was invited for a job interview to the best manage-
ment school in India, the Indian Institute of Management, Ahmedabad

(IIMA). As I did a good seminar and interview, the selection committee
offered me an assistant professor position, subject to my obtaining my doc-
toral degree. I took the letter of conditional offer and in desperation I
met the vice-chancellor of JNU, who happened to be a leading economist
in the country and a very kind person. He withdrew the thesis from the
examiner and appointed a new one. I had my thesis defense on 15 April,
1994 and immediately afterwards I took a train to Ahmedabad to take up
the position at IIMA. The four years I spent at IIMA as a faculty member
were the most gratifying professionally. During this period, I published
two papers from my doctoral thesis in the leading international journals,
theJournal of Development Studiesand the Journal of Economic Behavior and
Organization, and three papers on institutional economics in Economic and
Political Weekly.
In 1998, I was awarded the Fulbright Fellowship. Prof. Oliver
Williamson, the father of the new institutional economics, offered me an
invitation to the University of California, Berkeley (UCB). I spent one year
at the UCB reading extensively on NIE and closely interacting with Oliver
Williamson. He showed me that great scholarship and humaneness are
inclusive. During this time, I received an offer of tenured associate profes-
sorship from the Copenhagen Business School of Denmark. I took it, as I
wanted to see how capitalist institutions function in Europe. I had the
opportunity of ﬁrst-hand experience of the functioning of institutions of
capitalism in the three continents.
Amal Sanyal read the ﬁrst versions of all the chapters in this book and
gave very valuable comments. I beneﬁted from my discussions with Amar
Bhide, Rahul De, Deepak Sinha and Bent Petersen. Several arguments
and the underlying evidences are drawn from my papers, published over
the years in the following journals: Journal of Development Studies,Journal of
Economic Behavior and Organization,World Development,International Journal
of Management and Decision Making,Review of Applied Economics,Economic
and Political Weekly,Indian Economic JournalandIIMB Management Review.
On the personal front, when our father died at our very young age, my
brother, Narasimha Rao, took the responsibility of the family so that I
could pursue academics by trial and error. My uncle, Siva Ramakrishna-
iah, inspired my childhood with stories about great poets, philosophers
and scientists. My wife, Aruna, and daughters, Pratyusha and Nikhita, put
up with my difﬁcult times, and my broodiness when I was working on this
book. As the Upanishads of India say, ‘wondering of a tiny bubble on the
great ocean’.
Murali Patibandla
Indian Institute of Management, Bangalore, India
Prefacexv

Abbreviations
ADR American Depository Receipts
BPO business process operations
DFI Development Financial Institution
CII Confederation of Indian Industries
CMIE Center for Monitoring the Indian Economy
CSIR Center for Scientiﬁc and Industrial Research
FDI foreign direct investment
GDR Global Depository Receipts
GE General Electric
HP Hewlett-Packard
IMF International Monetary Fund
IPRs intellectual property rights
IT information technology
JIT just in time
MS Maruti-Suzuki
NASSCOM National Association of Software and Services Companies
NIS National Innovative System
NSE National Stock Exchange
RBI Reserve Bank of India
SBI State Bank of India
SEBI Securities Exchange Board of India
TNC transnational corporation
WTO World Trade Organization

1 Introduction
The 1980s and 1990s witnessed extraordinary changes in the world
economy. Several socialist and developing economies made a dramatic
move towards free markets and outward orientation after pursuing
decades of the socialistic economic system as activist states. At the same
time, a general reduction in barriers to international trade and investment
and rapid technological progress in information and communication
technology contributed to increasing globalization of the economic activ-
ity of nations. At the beginning of the millennium, China and India are
the two fastest-growing developing economies, with important implica-
tions in the world economy as they are also the two most populous coun-
tries.
1
One of the dominant reasons for their growth is the unleashing of
the free market forces of capitalism. While China remains politically a
communist state, it started to open its economy to free market forces and
the outside world in the late 1970s. On the other hand, economic reforms
in India relate to the reduction in excessive intervention in the economy
by the state, which took up a developmental role under a democratic
polity. Internal reforms were initiated in the middle of the 1980s and
major internal and external reforms began in 1991, necessitated by the
balance of payments crisis, with the help of the World Bank and Inter-
national Monetary Fund (IMF) structural adjustment and stabilization
program. India achieved an average annual growth rate of 6 percent
throughout the 1990s, and about 7 percent in the early 2000s, which is a
success story compared to a 3 percent Hindu growth rate in the 1970s and
the early 1980s.
The structural adjustment and stabilization program is basically a
package deal based on a textbook case of a free market mechanism in
which markets are the central institutions and others do not matter. As
the outcome of the reforms in India is fundamentally a success story, why
should we talk of institutions? If one examines India’s growth pattern, a
major part of growth beneﬁts have accrued mostly to the urban middle
class and there are signiﬁcant regional differences in growth levels. While
the states in the western and southern part of India have been growing at
a rapid pace, the large states in the north and some in the east remain

stagnant. Even after ﬁfteen years since the initiation of the reforms, close
to 300 million people remain below the poverty line and illiterate, outside
the market mechanism.
The international and intranational differences in the growth out-
comes of the reforms towards the free market economy can be traced
from differences in the initial endowments of capitalist institutions, apart
from technological and capital endowments at the onset of the reforms.
2
The new institutional economics emphasizes the importance of the insti-
tutions of capitalism, such as the rule of law, social and economic norms,
property and contractual rights and transaction costs of enforcement in
determining the economic prosperity of societies.
Ronald Coase (1992) in his Nobel lecture commented:
The value of including . . . institutional factors in the corpus of main-
stream economics is made clear by recent events in Eastern Europe.
These ex-communist countries are advised to move to a market
economy, and their leaders wish to do so, but without the appropriate
institutions no market economy of any signiﬁcance is possible. If we
knew more about our own economy, we would be in better position to
advise them.
The free market mechanism of the Western advanced capitalist nations
functions on the basis of underlying economic and political institutions
that have evolved through painstaking process over time. The following
illustration shows the importance of institutions in the efﬁcient function-
ing of capitalism. One of the indicators of economic development of
nations is the productivity of the workforce. In the mainstream neoclassi-
cal economics, productivity is determined by capital and technology. A
worker who has access to capital and better technology is more productive
than the one who works with inferior technology and less capital.
However, this is only a partial explanation. A worker with similar skills and
access to similar technology in India may still turn out to be less produc-
tive than one in the US because of the inefﬁcient market institutions he or
she operates in. Let us take three basic elements of economic institutions
to discuss this issue – property rights, incentives and transaction costs. A
person refrains from investing his/her efforts in a particular activity
(durable asset) if he or she is not sure of receiving the returns on the
investment, particularly if there is fear of appropriation by the state and
other private agents. A productive worker is not motivated if rewards
within an organization are not based on performance relative to peers,
that is, organizations (and societies) fail to adopt incentive-compatible
practices. A worker will be less productive in a given activity if he or she
has to divert her time and resources in dealing with transaction costs
(searching, information processing, paper work, long queues, etc.).
In analyzing the evolution of markets and institutions in response to
2Introduction

policy reforms, this book takes the following approach. From the neoclas-
sical economics, the evolution of markets can be viewed in terms of the
emergence of non-existing markets and of prices approaching long-run
marginal (opportunity) costs. The new institutional economics shows that
the presence of transaction costs due to information search and contracts
makes the costs of operating competitive markets non-zero. The efﬁciency
of markets is determined by minimizing transaction costs, but it is imposs-
ible to eliminate them, which leads to the issue of comparative economic
organization, elaborated on later. The new institutional economics makes
a distinction between the institutional environment (North, 1990) and the
institutions of governance (Williamson, 1985, 1998). The institutional
environment is deﬁned jointly by the rules of the game (the formal con-
straints: constitutions, laws, and property rights) and the conditions of
embeddedness (the informal constraints: sanctions, taboos, customs, tradi-
tions, and codes of conduct). The institutions of governance are market,
quasi-market, and hierarchical modes of contracting, more generally of
managing transactions and seeing economic activity through to comple-
tion (Williamson, 1998). The interaction between the institutional
environment and governance mechanisms determines the economic efﬁ-
ciency of exchange and incentives for investments in durable assets, both
physical and human (skills). Policy reforms refer to changes in certain ele-
ments of institutional environment, which, in turn, inﬂuence micro-level
governance mechanisms with feedback effects on the institutional
environment.
Policy reforms in the east European (transition) economies relate to
shifting from a socialist to a capitalist system. Shifts within the paradigm
imply that there exists a broad framework of capitalism, but with inefﬁ-
cient institutions, and that policy changes are necessary to improve these
institutional elements. This distinction is important because the funda-
mental paradigm shifts from communism to capitalism involve complex
issues and this book’s focus is on the development of institutions. I
approach the evolution of institutions under the condition that there is a
critical minimum level of capitalist institutions at the onset of economic
reforms, on the basis of which further evolution takes place.
3
The initial
institutional endowments are existence of a certain level of property
rights, and commercial laws (the rules of the game) so that there are
privately owned ﬁrms with functioning product and input markets.
4
Economic reforms are taken as exogenous shifts in certain elements of
the institutional environment which trigger an endogenous process of
evolution of markets and institutions. I make a distiction between parame-
ter and qualitative shifts. The former refer to quantitative changes in
taxes, exchange rates, tariffs, and licensing fees, etc., while the latter refer
to changes in the rules of the game between different players. To illustrate
the qualitative shifts, removal of licensing policies changes the rules of the
game between producers, consumers and government agents, for example
Introduction3

by increasing competition. The shifts change absolute and relative prices
in an economy (between different sectors and economic actors), as well as
the transaction costs of doing business in different spheres. This, in turn,
determines structural changes in terms of growth and the relative import-
ance of different sectors, and micro-level governance of technology and
organization through increased competitive dynamics. The direction of
the endogenous process is determined by initial institutional and market
endowments.
The changing economic interests of different agents and groups deter-
mine whether the reforms progress, and there will be cohesive bargaining
for effciency-enhancing institutional change. The importance of the initial
conditions is that they determine how soon the positive gains of the
reforms are realized, so that political interests become entrenched for
further efﬁciency-enhancing institutional change.
5
To illustrate the above point, in applying transaction-costs logic to polit-
ical aspects of the reform process, Dixit (1999) characterizes three phases
in the formation of interest groups under information asymmetry: ex
ante, interim, and ex post. At the ex ante stage, each individual is uncer-
tain about his own type (preferences) as well as the types of others
because there is no private information. At the interim stage, each indi-
vidual knows his own type, but not the types of others. The ex post stage is
when all players’ types are publicly revealed. In the case of countries such
as India, unlike Eastern Europe and China, one might start from the
interim stage because of the existence of powerful incumbents, both
private ﬁrms and the policy-makers, with their interests known at least for
the short term. Policy reforms would mean a fall in monopoly rents to
dominant incumbent ﬁrms and a decline in the control and rent-seeking
powers of government agents. To illustrate this with an example of indus-
trialists in India, when reforms initiated the process of liberalizing the
entry of transnational corporations (TNCs) in the mid-1980s, a few domin-
ant incumbent industrialists organized themselves into what was then
called ‘the Bombay Club’. They put forward the argument of a level
playing ﬁeld to lobby against the entry of TNCs. However, the reforms
continued in a slow process. By the early 2000s, two main beneﬁts of the
increasing presence of TNCs in the Indian economy became apparent.
The competitive dynamics between TNCs and local ﬁrms resulted in
several incumbent local ﬁrms becoming efﬁcient. Local ﬁrms started to
derive gains through the expansion of markets, a part of it caused by
increased competition (fall in prices). Second, the case of software and
service industries has shown the employment and export beneﬁts of
TNCs’ operations in India, which altered both the public and policy per-
ceptions about TNCs. Consequently, both the policy-makers and the main
industry body, the Confederation of Indian Industry, now want to attract
more foreign direct investment (FDI). Several companies who lobbied
against the entry of TNCs, have become multinational ﬁrms themselves by
4Introduction

investing in green-ﬁeld ventures and acquiring ﬁrms abroad by the early
2000s. The argument is that the reforms may make everybody better off in
the long run, but in the interim period the myopic interests of incum-
bents can block or distort the process. If the initial conditions are such
that the beneﬁts of the reforms are realized quickly, then institutional evo-
lution may not be blocked
India: a brief background
A major part of the reason for the positive outcome of economic reforms
is that India possessed a critical level of markets and capitalist institutions
on the basis of which policy reforms were undertaken. Several of the
initial endowment conditions were acquired both from the free market
mechanism of British rule and the import substitution policies of the post-
independence period since 1947.
India’s economy in the early part of the twentieth century under the
British rule was basically a free market economy, which declined
economically (Clark and Wolcott, 2001). However, British rule established
a critical level of infrastructure conditions for free markets in terms of rail-
roads and telegraphs, which reduced the transaction costs of trade both
internally and internationally, and certain elements of capitalist institu-
tions of contract and property laws through the adoption of Common
Law, which continued after independence. At the time of independence
in 1947, the Indian leadership bestowed on the government the respons-
ibility of overcoming India’s poverty and achieving economic prosperity.
In order to achieve this objective, the government adopted a highly inter-
ventionist planning system for rapid industrialization, with relative success,
accelerating the aggregate growth rate to about 6 percent in the 1950s
and early 1960s. In the following decades, the growth rate declined to a
‘Hindu growth rate’ of 3 percent as the state started to impose several con-
trols and transaction costs on economic actors in the name of socialism
and eradicating poverty.
The dominant philosophy in development economics in the 1950s was
that developing economies, most of which were victims of colonial rule,
required a ‘big push’ by the state taking up the developmental role. The
basic concern was that the private sector would be unable to save enough,
and government was seen to be in a position to lift the saving rate through
budgetary manipulations (Nurske, 1953). Apart from this, there was the
concept of ‘development externalities’ drawn from Hirschman’s (1958)
theory of sectoral linkages, namely that private investments in individual
products were unproﬁtable unless there were a concerted program of
investment in a number of complementary sectors, each providing
demand and reducing costs for the other. This required massive invest-
ments simultaneously in different sectors such as railroads, power, roads,
banking, mining, and heavy industry. At that time, government alone was
Introduction5

in a position to undertake the investment because, singly, private investors
would have found it unproﬁtable. These investments by the government
reduced several types of transaction costs by generating developmental
externalities, contributing to increased growth rates in the 1950s and early
1960s. Similarly, the active policy intervention in the agriculture sector in
the late 1960s contributed to the Green Revolution, which made India
self-sufﬁcient in food grain production within a short period. However, as
the policy intervention increased over time, creating vested interest
groups with rent-seeking interests (bureaucracy, politicians, and the mon-
opoly businesses), the government started to impose new types of transac-
tion costs on private activity, thereby stunting growth.
In several areas, the stock of the previous government investments
made it easy for private sector and markets to take over and reduce trans-
action costs signiﬁcantly in the post-reform era. One example is the com-
munication sector. Another is the government’s massive investment in
higher education for facilitating import substitution, which became the
basis for high-tech industries such as the software and pharmaceutical
industries to expand signiﬁcantly in the post-reform period (Patibandla et
al., 2000). The other side of the story is that the government intervention
took on a life of its own as it became a major source of rents to govern-
ment agents and powerful incumbents, imposing efﬁciency-curtailing
transaction costs at every level of economic activity. This trapped the
economy into distributional politics at the cost of wealth-generation
(Sanyal, 1984; Bardhan, 1984). As mentioned before, India’s growth in
the post-reform period remains fragmented, with close to 300 million
people below the poverty line and outside the market economy. One pos-
sible explanation is that, in the pursuit of heavy industrialization, the pre-
vious government ignored the generation of universal primary and
secondary education and the generation of social security systems (or land
reforms), and thereby failed to create conditions of ‘equality of opportun-
ity’ for its people.
As is well known in the literature on India, the major economic reforms
of 1991 were made possible by the balance of payments crisis, a crisis
driven reform in a complex democratic polity. Although the reforms of
1991 can be considered a major policy shock, they were only a partial
reduction in government intervention, and the subsequent reform
process continues in a slow process owing to the complex web of interac-
tions of the different interest groups. To exemplify this observation, the
Indian economy averaged about 7 percent growth rate, its foreign
exchange reserves crossed $100 billion and the country came to be known
globally as a software superpower in the early 2000s. The then ruling NDA
(National Democratic Alliance) government went to the elections in 2004
with the slogan of ‘India Shining’, but lost. The Congress party in coali-
tion with the communist parties formed the government at the center.
One of the explanations given for the fall of the NDA government by
6Introduction

several writers in the popular press (including Salman Rushdie) was that
the economic reforms and growth beneﬁted only the rich and the middle
class, while a large section of the rural poor were left behind. The reforms
process continues slowly with a complex interaction between the coalition
members, the Communist Party, which wants to block market-friendly
reforms, and the Prime Minister, Dr Manmohan Singh, an eminent econ-
omist, who favours reforms and was the major architect of the 1991
reforms as the then ﬁnance minister.
India is probably the most interesting case among the emerging
economies with which to study the evolution of markets and institutions in
response to economic reforms, owing to its democratic polity, which is
characterized as ‘one polity and many countries’ (Clark and Wolcott,
2001). India as a nation-state is like putting all of Europe into one
country. When the East Asian economies and China were growing at a
rapid pace in the 1980s, they were called ‘Tigers’ in the popular press. In
view of her slow growth rate and the presence of a large section of poor
and illiterate people, India is generally referred to as a ‘lumbering ele-
phant’. A few attribute this to the way in which democracy functions in
India, while the East Asian countries and China have been able to imple-
ment policy changes quickly because of their totalitarian systems. As men-
tioned before, India, unlike the Eastern European countries and China,
has a critical level of markets and capitalist institutions acquired both
from British rule and under the Fabian socialist policies of the pre-
reforms period. The institutional evolution in response to the policy
reforms operates from the basis of the initial conditions under a complex
democratic process. These factors make India an interesting case and at
the same time render the task at hand a very difﬁcult one. Just to give an
example, the striking duality of India is that in the early 2000s, India has
come to be known as a great destination for outsourcing of high-tech jobs
in the areas of software and services, pharmaceutical, and biotechnology
industries. One of the results of the reforms is by the early 2000s India had
started to produce a few indigenous, world-class companies both in the
service and manufacturing industries. There has been a rapid increase in
the incomes of especially the urban middle class. At the same time, she
houses the largest number of poor and illiterate people in the world.
A few conceptual issues
Does evolution of markets and institutions refer to movements towards an
optimum? Arrow-Debreu’s general equilibrium theory of the neo-classical
economics is basically a formalization of Adam Smith’s idea of the ‘invisi-
ble hand’ of free markets, which shows the efﬁciency of free markets
through the lens of the Pareto optimality conditions. In the presence of a
complete set of markets, prices in equilibrium reﬂect their true opportun-
ity costs in space and time. With a large number of perfectly rational
Introduction7

anonymous agents with perfect foresight under an assumed perfect set of
markets, the model shows how free markets lead to Pareto optimal out-
comes of welfare. If one goes by the optimality criteria, policy reforms
should be aimed at letting these conditions prevail either by withdrawing
government controls or by public policy intervention in speciﬁc spheres,
depending on the nature of the market failure. Market failure refers to
the presence of externalities and non-convexities. Any student of eco-
nomics knows that it is literally impossible to meet all the conditions
necessary for Arrow-Debreu general equilibrium in the real world, which,
in turn, can be used to justify selective policy intervention in correcting
for market failures. If government intervened as a result of market failure
considerations in the ﬁrst place, where is the need for reforms eliminating
government intervention? The question leads to the notion of ‘govern-
ment failure’. Ronald Coase envisaged the notion of government failure
as early as 1964 through his conceptualization of comparative economic
organization.
6
Commenting on the obsession of the economics profession
with the frictionless free markets, he observed,
It has led economists to derive conclusions for economic policy from
a study of an abstract of a market situation. It is no accident that in
the literature . . . we ﬁnd a category of market failure but no category
of government failure. Until we realize that we are choosing between
social arrangements which are more or less failures, we are not likely
to make much headway.
The Arrow-Debreu general equilibrium theory helps in identifying differ-
ent conditions necessary for the efﬁcient functioning of markets under
the equilibrium criteria of collective economic welfare of societies (Arrow,
1964). Where does the notion of economic institutions of capitalism
become germane? One of the fundamental assumptions of the neo-
classical economics is that people participate in economic activity as
anonymous and autonomous agents acting in a large group context. We
all know that a major part of economic activity is organized with more
than one agent as a group or an organization. For several reasons of indi-
visibility of economic tasks, collective action results in higher surplus than
individual action, and economic activity by organizations instead of by
single individuals reduces the transaction costs of markets – ‘Robinson
Crusoe gets married’. The rules and norms at the micro level of ﬁrms,
bureaus, and societies at large are a result of collective action of the public
and private order institutions.
When economic exchange moves from small-group to large-group
exchange, it results in a high degree of uncertainty for economic agents in
ﬁguring out the attributes, and ownership rights of what is exchanged
(North, 1990). High uncertainty reduces gains through specialization and
expansion of markets and number of transactions, thereby stunting eco-
8Introduction

nomic progress. This is where government, which can be viewed as a
public order institutional arrangement, has to deﬁne and enforce the
rules of the game so that uncertainty of exchange is minimized. Countries
that are able to arrive at governance mechanisms that bring out a ﬁne
balance between individual incentives and the formal and informal rules
formed by collective action are the ones that facilitate free markets to gen-
erate material prosperity at large. But there is no theory of this ‘thin red
line’ of ﬁne balance or its optimality, which makes the logic of compara-
tive economics logical. To exemplify this, the US can be considered the
most advanced capitalist economy at present. The major corporate fail-
ures in the early 2000s, which destroyed savings worth billions of dollars
through corporate misgovernance, illustrate the institutional failures.
Another example is the East Asian ﬁnancial crisis of 1997. Until the crisis,
the high economic growth rate of these economies was termed the East
Asian miracle. The ﬁnancial crisis was seen as a result of institutional fail-
ures. Countries such as South Korea, which were able to undertake institu-
tional reforms, recovered relatively quickly from the after-effects of the
ﬁnancial crisis, in contrast to the other East Asian economies.
The new institutional economics takes the approach that an institu-
tional framework for efﬁciency considerations should be examined in a
comparative economic organization perspective. At a given point of time,
a conﬁguration of institutional elements may result in relatively high eco-
nomic efﬁciency in comparison to the past and in relation to other soci-
eties. However, a similar conﬁguration may result in relative inefﬁciency
in the future when certain external factors change or when a new set of
goals and benchmarks come into play for judging efﬁciency. The institu-
tional evolution (or change) in this context implies the ability of societies
to realign economic organization in accordance with the external changes
or in relation to emergence of superior forms of institutional conﬁgura-
tion for benchmarking.
The new institutional economics took its roots in the transaction cost
theory of the ﬁrm as an economic organization rather than purely a pro-
duction function, following the seminal paper of Ronald Coase on ‘The
Nature of the Firm’ (1937). Later, scholars such as Oliver Williamson,
Douglas North and others developed and extended the basic idea into the
ﬁeld of the new institutional economics. Williamson’s main focus is on the
issue of devising economic organizations that mitigate transaction costs of
market exchange from a science of contract perspective. The main moti-
vation behind his work was to understand vertical integration strategies of
ﬁrms, which led to his seminal book, Markets and Hierarchies(1975), with
the basic idea that ﬁrms adopt vertical integration for economizing on
transaction costs of contracts and their enforcement. Once production is
internally organized, individual choices and incentives are governed by
hierarchical organizational structure in which incentives become low-
powered, as compared to high-powered incentives of markets. Once we
Introduction9

bring in the contractual aspect of economic activity, the issue becomes the
ability of agents in a transaction to align incentives and to devise gover-
nance structures that are better attuned to their exchange needs. By this
reasoning, Williamson brings forth a comparative economic organization
approach to institutional aspects of economies. When superior feasible
forms of organizing economic activity can be described and implemented,
one has to ﬁnd what the underlying governing factors are and how they
can be achieved. In other words, this approach of comparative economic
organization observes economic efﬁciency in terms of choices among
alternative arrangements that show their relative economic merits. A
similar economic activity under different institutional environments may
exhibit different levels of economic efﬁciency.
Williamson’s approach to organizational economics can be extended to a
broader level of looking at an economy as an organization. In an economy,
individual choices are constrained by scarcity of economic resources and
also economic, social, and political institutions. In other words, economic
activity is organized in an economy by balancing trade-offs between high-
powered incentives of individual choices and low-powered incentives of
institutional constraints. For example, in the Western capitalist societies,
complex institutional structures at the constitutional and corporate level
have been devised and implemented over time in order to constrain eco-
nomic agents, so as to reduce the uncertainty of social interaction and
prevent transactions from being too costly. Following from this, one can
take the view that one of the major sources of development of the Western
capitalist societies is their ability to ﬁnd a ﬁne balance between high- and
low-powered incentives in economic organization.
The essential issue here is that comparative economic organizational
approach implies understanding and analysing feasible forms of relative
efﬁciency in both space and time, and nothing can be called an optimum
institution. For example, economists have not yet developed a theory to say
a particular organizational structure is the optimum. Organization of eco-
nomic activity internally involves several elements, such as teamwork and
monitoring (Alchian and Demsetz, 1972), hierarchy versus high-powered
incentives of individuals (Williamson, 1975), agency relations, and incen-
tives (Holmstrom, 1979) within an organization. There is no such thing as
an optimal combination of these factors. At best, one can benchmark one
form of organization against another to understand relative efﬁciency.
The international context: comparative economic
organization
In terms of human and physical capital and natural resource endowments,
Russia can be termed one of the richest nations in the world. The country
has 100 percent literacy, a large number of highly trained technical per-
sonnel and a large base of natural resources. However, Russia’s sudden
10Introduction

move from a socialist to a capitalist economy in the absence of minimum
capitalist institutions resulted in disastrous consequences. This also led to
the emergence of perverse institutions of the politically powerful Commu-
nist Party members conﬁscating a major part of the stock of government
assets, and the emergence of the maﬁa in determining and enforcing
property rights. Similarly, Nigeria was termed a middle-income country
about twenty years ago, with a large natural-resource base. Despite its free
market policies and openness to international trade and investment, it
declined economically over the years, with erosion of institutional con-
ditions caused by the emergence of a series of military dictators, who
destroyed property rights and the conditions necessary for productive
investment.
During the last 200 years, the Western capitalist economies have pre-
sented the case of capitalism with democracy, except in the case of
Germany for a brief period between the First and Second World Wars
under Hitler (of course, Hitler came into power through democratic elec-
tions). Japan and South Korea present the case of remarkable growth in
the post-Second World War era. Japan’s rapid growth was under demo-
cratic polity.
One of the dramatic economic stories of the 1980s and 1990s is the
rapid growth and subsequent ﬁnancial crisis (of 1997) of the East Asian
economies. Among these economies, South Korea presents a highly suc-
cessful story. The country achieved spectacular economic growth from the
early part of 1960s under the polity of dictatorship of President Park.
Under the hard-state system, the state implemented signiﬁcant institutional
reforms such as land reforms, the breaking-up of the trade union power
and the forcing of the rich to convert assets to productive activities. The
political system implemented an incentive mechanism of ‘carrot and stick’.
Industrial groups that were identiﬁed as potential winners in international
markets were provided with preferential access to capital and resources
and were made to perform in accordance with the objectives set by the
government. The forced cooperation between the state and the private
sector also facilitated periodic assessment of the possible strategies to be
adopted in accordance with changing market conditions. This model trans-
formed South Korea from a poor country to an advanced economy by the
early part of the 1990s, within twenty years of the implementation of the
development strategy. South Korea’s industrialization strategy, that of
activist state, was similar to that of Japan, with the main difference in the
polity (Amsden, 1989; Pack and Westphal, 1986). The ‘follower’ East Asian
countries, such as Malaysia, Indonesia and Thailand, adopted market
economies open to international trade and investment under authoritarian
political systems. These countries experienced rapid economic growth
rates until the ﬁnancial crisis of 1997 slowed them down.
After a prolonged period of rapid expansion, the Japanese economy
started stagnating in the 1990s. The East Asian ﬁnancial crisis involving
Introduction11

South Korea, Malaysia, Thailand and Indonesia put a brake on the rapid
growth rates. These outcomes are generally explained as a result of macro-
economic policy mismanagement and institutional deﬁciencies of the
market economy models adopted by these countries. Krugman (1994)
termed the market economy model of the East Asian Economies ‘Crony
Capitalism’ – an institutional arrangement of insider dealings of powerful
industrialists, bankers, and government agents. In assessing the East Asian
ﬁnancial crisis of 1997, the editorial of the Far Eastern Economic Review(8
January 1998) observed,
The skid-marks all point to one source: the lack of accountability, gener-
ally stemming from the too-cozy relationship between government and
business. In South Korea, banks acted as investment arms of the govern-
ment, with risk analysis almost unheard of. In Indonesia, the ﬁrst family
lavished preferential licenses for everything from cellular phones to the
ill-starred Timor national car on presidential kin and cronies. In Thai-
land, ﬁnancial institutions, which fed a real-estate bubble, could count
on political connections to keep the problem hidden until the pressures
became too great. And in Japan, each time a company goes belly up we
learn that its bad debts are many times higher than the ofﬁcial ﬁgure.
This, of course, is just what we might expect from systems where capital
is diverted from its most efﬁcient uses and whose opacity allows players
to hide the costs of these diversions.
In other words, the institutional arrangements of the market mechanism
played a very important role for both the rapid growth rates and sub-
sequent ﬁnancial crisis in these economies (Patibandla and Prusti, 1998).
South Korea, which implemented certain institutional reforms in corpor-
ate governance mechanisms and functioning of the banking system, recov-
ered quite quickly from the ﬁnancial crisis.
The Japanese institutional mechanism of lifetime employment practice,
close relations between banks and big business, and organizational prac-
tices which were different from the Western capitalist practices was glori-
ﬁed during its rapid growth of 1950–90. However, the prolonged
recession of Japan since the early 1990s is generally attributed to its insti-
tutional deﬁciencies. Some observers of Japan attribute the slow process of
institutional reforms to the functioning of the Japanese social system.
The importance of political elements in shaping capitalist institutions
comes out strikingly in the context of emerging economies of the present
from the comparative analysis of China and India. In the early part of the
2000s, China and India are considered the two-fastest growing developing
economies, with highly divergent political institutions. China is able to
achieve rapid economic growth rates by combining its communist political
institutions of party dictatorship with capitalist market forces. On the
other hand, India’s transition from a highly-state interventionist model to
12Introduction

freer markets has been done under democracy. India’s economic growth
and institutional evolution take place under a complex web of political
equations of a federal democracy.
Until 1978, China was one of the most autarkic economies in the world.
The economic stagnation under communism, the high economic and
social costs of the Cultural Revolution under Mao and the changes in the
geopolitical equations prompted the Chinese government to open up its
economy to the outside world in 1978 under the leadership of Deng
Xiaoping. The Chinese state, in its attempts to retain the communist
philosophy of state ownership of capital, undertook external reforms of
opening up to foreign capital ﬁrst and kept the basic internal structure
unreformed. In the process, it created a peculiar institutional framework.
In order to utilize foreign capital and technology for economic growth,
the state bestowed property rights and free mobility within the country to
foreign capital, but not to local private agents. Limited property rights
given to local agents are termed ambiguous property rights (Li, 1996).
The Chinese state created a political pecking order in which at the top
were the state-owned enterprises (SOEs) and at the bottom were the
private ﬁrms (Huang, 2002). The major component of the non-state
sector (private) was collective enterprises – rural enterprises and the
Township and Village Enterprises. The collective enterprises were not
totally private because local government involvement in the provision of
production and services allowed the government agents to exercise a
degree of control rights on the enterprises. The government agents were
involved in several spheres of investment decisions, proﬁt-sharing, bar-
gaining and the issue of local taxes. The decentralized nature of the
Chinese state provided a certain degree of alignment of incentives of local
government agents with the private agents of the collective enterprises for
proﬁt generation instead of pure predation.
Private agents in the industrial sector were denied private property
rights until 1998. Moreover, access to capital was made very difﬁcult for
them. However, the state used foreign capital to bring about a peculiar
system of capitalist incentives. Under China’s decentralized economic
system, local governments restricted trade and capital ﬂows to other
regions: domestic ﬁrms were not allowed to invest outside their regional
jurisdiction, while there were no similar restrictions on foreign ﬁrms. This
created peculiar incentives for local private ﬁrms to convert their busi-
nesses to foreign ones: one reason was to get access to capital, and the
other was to obtain legal property rights. The private ﬁrms, therefore,
took their limited capital out to neighboring countries such as Hong
Kong, Taiwan and Singapore and brought it back as foreign capital in
order to be recognized as foreign-owned ﬁrms. Private ﬁrms also got into
equity arrangements with foreign ﬁrms mostly from neighboring coun-
tries in order to get access to capital and achieve formal recognition as
foreign ﬁrms (Huang, 2002).
Introduction13

On the other hand, SOEs had generous access to capital from the state,
but most of them were operationally highly inefﬁcient. In order to over-
come the operational inefﬁciencies of SOEs, the state used foreign capital
to privatize them, as local private agents were not allowed to acquire
private property. With this valuable asset base, SOEs became proﬁtable
targets for acquisition by multinational ﬁrms. Despite high domestic
savings rates in China, Chinese institutional mechanisms caused large
ﬂows of foreign capital, which became a major source for economic
growth. However, it is at the cost of economic efﬁciency – if the local
agents were given property rights and allowed to bid and compete with
transnational corporations (TNCs), it could have resulted in higher
growth beneﬁts through competitive dynamics (Patibandla, 2002b).
The other side of this success story is that of China’s Township and
Village Enterprises (TVEs). TVEs are cooperative institutional arrange-
ments with common ownership of capital of local people. Their economic
performance has been highly remarkable. In 1991, there were about
nineteen million TVEs, which made up about 67 percent of the rural
industrial sector. As Levi and Pellegrin-Rescia (1997) observe,
The TVEs have been characterized as organizations where there is no
owner according to the traditional property rights theory: there is no
residual claimant in the traditional sense and the assets are non-
sellable, nontransferable and non-inheritable. Ownership and control
are mainly collective and community based.
Membership is not voluntary but all local residents have automatic mem-
bership, an institutional arrangement initiated (or imposed) by the
government. Unlike the SOEs, which were provided with large sums of
capital under soft budget constraints, TVEs were subject to hard budget
constraints and to competitive market conditions. Their total factor pro-
ductivity during 1979–91 grew three times faster than that of SOEs, com-
parable to the private ﬁrms. What explains their success?
One way it can be interpreted is that it is a combination of capitalist
incentives of hard budget constraints and competitive markets and a coop-
erative institutional arrangement under commitment, not in terms of
membership (as it is involuntary), but in terms of restraining free-riding.
When each TVE is able to realize high productivity and compete effect-
ively, it generates surplus for all members. All members, being local resid-
ents, have a social commitment to the small communities and TVEs are an
economic extension of the social commitment. A free-rider may face
social stigma similar to that which can occur in a small society in which
cheating in economic exchange results in social boycott. Furthermore, as
long as an individual is better off being a member of the cooperative than
defecting, he or she has the incentive to develop commitment.
In China, the centralization of power in the hands of the Communist
14Introduction

Party, with limited legal rights to local agents, allows government to
undertake policy changes that suit its interests without much resistance.
India, on the other hand, is a federal democratic polity under the parlia-
mentarian system with diffused powers and three autonomous branches of
state – the legislative, the executive and the judiciary. The government
donned the mantle of a development state with pervasive intervention in
economic activity from 1950 to 1991, which led to a large presence of the
public sector and numerous commands and controls on the private sector
(Mohan and Aggarwal, 1990). Under democracy and the semblance of a
mixed economy, private agents were given property rights, but these were
modiﬁed by several controls. The property rights led to the emergence of
a large base of private sector ﬁrms in the organized and non-organized
sectors. However, the pervasive government intervention also led to the
emergence of a few organized vested interest groups – the politicians and
bureaucrats, the organized industrialists, organized labor, and the large
landholders. The distributional politics and rent-seeking behavior of these
powerful groups generated economic inefﬁciencies and stunted the
growth rate to an annual average rate of 3 percent from 1960 till the early
1980s. The government of India initiated a slow process of economic
reforms in the mid-1980s and major reforms were implemented in 1991.
Since 1991, the reforms process in several spheres continues slowly with a
complex web of calculations, as mentioned before.
Unlike China, India moved on the internal front ﬁrst and external
reforms were undertaken later in a slow and gradual fashion. Under
democracy, the political equations favor domestic capital – removing the
controls on the domestic capital ﬁrst and introducing competition from
foreign capital at a later stage. In the case of communist China, private
property rights were perceived as a threat to the state and it therefore
used foreign capital to bring about the incentives of capitalism for aug-
menting economic growth. India’s Fabian socialist policies of the previous
policy regime under democracy, in spite of generating pervasive inefﬁ-
ciencies with institutional controls on the markets, did not destroy the
capitalist forces of private property. Consequently, it led to the emergence
of a strong local entrepreneurial class, which became the basis for rapid
industrial growth in the post-reform era. The policies also generated a rea-
sonably well-functioning institutional infrastructure for private capital –
the well-developed capital markets, local managerial talent, endowment of
skilled workers, and a functioning legal system, although with high trans-
action costs. When the gradual elimination of controls on markets was ini-
tiated from the mid-1980s, it led to growth of a signiﬁcant number of
indigenously born companies that could compete internationally. Further-
more, the reforms also led to rapid growth of internationally competitive
knowledge-based industries such as the software, business processing and
pharmaceutical industries.
In essence, while India is considered to have evolved its capitalist forces
Introduction15

from the ground up, China has been pursuing a top-down approach,
which is attributed to their contrasting political systems of democracy and
totalitarian communism (Huang and Khanna, 2003; Patibandla, 2002b).
China has been experiencing a faster economic growth rate than India,
one of the reasons being a higher savings rate, and large inﬂows of foreign
capital. India’s savings and gross domestic capital formation have been
much lower but the ground-up approach to free markets has resulted in
better utilization of capital (Sutton, 2004).
Table 1 shows some of the indices of economic freedom in India and
China. On most counts of the measures of economic freedom, China and
India are on equal footing, but one has to go into micro level details to
understand the differences in the functioning of the institutions. This is
illustrated by a comparative analysis of the clearance and operation of
large infrastructure projects in China and India. In the case of India’s
federal democracy, clearance of large projects is more complex, involving
the federal government at the center, the state government and several
other regulatory agencies such as the environmental regulators. The regu-
latory decisions governing issues such as zoning, land use, and environ-
ment vary from one state to the other. The investment approval in India is
made at the central level, while implementation is left to state govern-
ments. The regulatory system allows for bureaucratic discretion. Apart
from this, if corrupt practices are suspected, government clearances of
projects can be politicized by the independent press, which can delay pro-
jects. Furthermore, the independent judiciary can also be a source of high
transaction costs. For example, the Enron Corporation, in its involvement
with the Dabhol Power Company (DPC), had to ﬁght about twenty-seven
court cases ﬁled by private parties under public interest litigation and
environmental grounds.
On the other hand, the centralized nature of the decision-making on
the clearance of large foreign direct investment (FDI) projects in commu-
nist China provides a clearer signal for the target of negotiation and fast-
track clearances for investors. Moreover, government contracts are not
subject to litigation by private parties. The centralized decision-making,
however, increases the contractual hazards of cancellation as the judiciary
and different layers of government do not provide safeguards to contracts.
Centralization of power with regard to clearing of large projects makes
this process subject to lower transaction costs in China than in India. At
the operational level, China poses higher transaction costs as a result of
predation by local government agents since the local governments hold
signiﬁcant regulatory powers and powers of enforcement. As the rules are
not transparent, the regulation is subject to a high degree of discretion by
the local agents (Ahlstrom, Bruton and Lui, 2000).
7
The question that
follows is, if contractual hazards are very high in China, why is it attracting
large amounts of foreign capital in the infrastructure projects with a lot of
sunk costs? A probable explanation could be the investors who show risk-
16Introduction

Table 1Index of economic freedom
Overall Country Overall Trade Fiscal Government Monetary Foreign Banking/ Wages/ Property Regulation Black
rank score burden intervention policy investment ﬁnance prices rights market
6 United States 1.80 2.0 3.5 2.0 1.0 2.0 1.0 2.0 1.0 2.0 1.5
119 India 3.50 5.0 4.0 3.0 2.0 3.0 4.0 3.0 3.0 4.0 4.0
127 China 3.55 5.0 3.0 4.0 1.0 4.0 4.0 3.0 4.0 4.0 3.5 Source: The Heritage Foundation – Wall Street Journal .
Note
The Index of Economic Freedom (IEF) has offered the international community an annual in-depth examination of the factors that contribute most
directly to economic freedom and prosperity. The IEF includes the broadest array of institutional factors determining economic freedom:
• Corruption in the judiciary, customs, and government bureaucracy;
• Non-tariff barriers to trade, such as import bans and quotas, as well as strict labeling and licensing requirements;
• The ﬁscal burden of government, which encompasses income tax rates, corporate tax rates, and government expenditures as a perc entage of output;
• The rule of law, reliability, impartiality, and efﬁciency of the judiciary, and the ability to enforce contracts;
• Regulatory burdens on business, including health, safety, and environmental regulation;
• Restrictions on banks regarding ﬁnancial services, such as selling securities and insurance;
• Labor market regulations, such as established work weeks and mandatory separation pay; and
• Black market activities, including smuggling, piracy of intellectual property rights, and the underground provision of labor a nd other services.

taking behavior – gains from a large market might be worth the risk. One
of the main factors for China’s higher growth is that it built a good infra-
structure, while the corresponding infrastructure investment in India,
both by the private and foreign investors, has been low, owing to high
market transaction costs of the government clearances (Patibandla,
2005b).
The comparative economic organization approach to economic efﬁ-
ciency is quite useful in understanding evolution of markets and institu-
tions in developing economies. One can benchmark the institutional
change by comparing it across developed and developing economies and
also in terms of improvements over time in the efﬁciency of economic
organizations. The approach helps us to test the proposition of conver-
gence of best practices. Economic reforms increase global integration
through trade and multinational investment, which make it possible for
local ﬁrms to imitate global best practices through competition, and
through the demonstration effect. In this context, where does the neoclas-
sical price theory become germane? It helps in getting some of the market
conditions right. For example, the theory of contestable markets shows
that monopoly power can be curtailed when markets are contestable,
which requires entry and exit costs to be zero. One of the conditions for
entry costs to be zero is a perfect capital market, which means that a new
entrant with a good project can raise capital without collateral and
compete with incumbents. Although it may not be possible to have some-
thing called a perfect capital market in the real world, government pol-
icies can be aimed at reducing capital market imperfections by reducing
transaction costs and informational asymmetries. For example, one of the
underlying reasons for the East Asian ﬁnancial crisis was the collusion
between big banks and conglomerates under poor disclosure (corporate
governance) practices, which led to misuse of capital. Government, by
establishing legal conditions that improve disclosures and curtail collu-
sion, can improve the functioning of the markets. As mentioned before,
South Korea recovered quickly from the ﬁnancial crisis because of the
government reforms on these fronts.
Methodological issues
The main notion of the new institutional economics is that of the transac-
tion costs of the exchange mechanism of capitalism. The growing liter-
ature in the new institutional economics has extended its implications to
larger issues both at the micro level of governance and macro level of the
institutional environment. In several instances, it is criticized that every-
thing can be called transaction costs. Williamson, in a series of inﬂuential
papers which I discuss in Chapter 2, formalized the notion of transaction
costs systematically. However, it is difﬁcult to measure and capture several
dimensions of transaction costs empirically in a precise way, which obliges
18Introduction

us to work with proxies. I make use of both quantitative and qualitative
information in deriving inferences on macro level issues relating to struc-
tural changes and evolution of public and private order institutions, and
micro level issues relating to competitive dynamics and technological and
organizational changes.
It is pertinent to mention here that if one looks at the improvements in
the institutions in terms of the reduction in transaction costs of exchange
mechanisms, it is not a straightforward issue to understand the effect of
reforms on economic activity. This is because on one hand the reforms
will reduce transaction costs of dealing with governments, and on the
other hand, they could result in increases in other forms of transaction
costs if economic growth increases complexity, uncertainty and frequency
of exchange. This varies in different activities depending on the complex-
ity of contracts and investments in durable and speciﬁc assets. In some
spheres, transaction costs can go up as a result of increasing complexity of
exchange and technology. The overall efﬁciency of economic activity can
increase because it is determined by the combination of transformation
(technology and organization) and transaction costs, if technological
progress and economies of specialization outweigh increase in transaction
costs. Apart from this, as growth takes place, aggregate transaction costs
increase, but the average cost to the individual declines, which is an indi-
cation of improvements in market exchange. With the changing nature of
transaction costs, organizations (ﬁrms and governments) have to alter gov-
ernance structures for reducing the transaction costs of the exchange
mechanism over time. This can take place at different levels, both at the
micro level of ﬁrms and individuals, and at the collective (macro) level. I
examine these issues from the analysis of structural dynamics and from
the micro level analysis of ﬁrms and industries.
The evolution of markets and institutions involves a gamut of complex
issues and different spheres of economic organization in an economy.
This book conﬁnes itself mostly to the study of the industrial sector. It
draws a simple analytical framework in Chapter 2, which serves as the
basic structure for the analysis of the rest of the book. The framework
brings forth the deﬁnitions of markets and economic institutions and
mechanisms of their evolution in response to the policy reforms. Chapter
3 characterizes the initial endowments of markets and institutions and the
policy reforms implemented in India. Chapter 4 examines the structural
changes of the economy in response to the reforms. Chapter 5 analyses
competitive dynamics, especially among incumbent ﬁrms and new entrant
TNCs, and tests the proposition that competition causes convergence of
best practices. The focus of Chapter 6 is on technological change at ﬁrm
and industry level and on the evolution of the National Innovative System
(NIS) and their implications on the evolution of markets and institutions.
Chapter 7 examines organizational change at ﬁrm and industry level,
which covers issues such as ownership, decentralization of organization,
Introduction19

corporate governance, and standalone companies, and ﬁnally evolution of
market structure. Chapter 8 examines the evolution of public and private
order institutions and Chapter 9 provides concluding remarks.
The empirical analysis is based on both quantitative econometric analy-
sis of industry and ﬁrm level data pertaining to the post-reform period
and qualitative analysis of case studies of ﬁrms and industries. Given the
limitations in capturing the evolutionary dynamics empirically, in several
instances the inferences are drawn indirectly with underlying conceptual
constructs. To illustrate this point, if we ﬁnd a positive empirical associ-
ation between ﬁrms’ market share in an industry with relative production
efﬁciency, it implies that prices are approaching long-run marginal costs
based on the oligopoly theory. Decline in prices implies increase in real
incomes, which results in increased consumption and savings, and which,
in turn, is analyzed for its implications on the evolution of markets and
institutions.
20Introduction

2 The conceptual framework
The analytical framework of this chapter serves as a basic conceptual struc-
ture for the discussion of the following chapters in tracing the evolution of
markets and institutions. To recall, I take the approach that policy reforms
are parameter and qualitative shifts in certain elements of the institutional
environment which change prices and transaction costs in different spheres
of economic activity. This has implications on structural changes of aggreg-
ate growth of different industries and micro level governance mechanisms.
Structural changes and improvements in micro level governance mechan-
isms, in turn, engender evolution of markets and institutions.
I brieﬂy discuss what I mean by policy reforms as parameter and
qualitative shifts in elements of the institutional environment. More
detailed discussion of this issue comes in the following chapters. Parame-
ter shifts refer to quantitative changes in spheres such as taxes, licensing
fees, tariffs, and exchange and interest rates. Qualitative changes refer to
changes in the policy framework such as the removal of licensing, reserva-
tion for small-scale industry and quantitative restrictions on imports. Para-
meter shifts change relative and absolute prices and transaction costs in
different spheres and facilitate resource mobilization for productive use.
For example, reductions in import tariffs and exchange rate movements
change the relative prices faced by different industries.
Qualitative shifts in the institutional environment eliminate some trans-
action costs once and for all and change the rules of the game between
different economic agents. For example, the removal of licensing policies
eliminates the transaction costs of acquiring licenses and hence the need
for special organizational forms of ﬁrms set up for lobbying with the
government. The removal of licensing and capacity restriction policies
increases competition between incumbents and new entrants. It also
causes a reduction in the predatory powers of government agents with
respect to producers, and an increase in the bargaining power of con-
sumers and workers with respect to producers. The evolution of markets
and institutions is an outcome of the repeated play by all participants –
ﬁrms, consumers, workers, investors and governments – in the various
decision games, after the initial changes in the rules of the game.

In the following paragraphs, I discuss the deﬁnition of markets and
economic institutions and trace the mechanism of their evolution.
Markets
In the neoclassical theory, markets are central institutions in which indi-
vidual actions interact. An economy can be seen broadly as consisting of
two markets: product and factor markets (labor, capital and land). Under
frictionless exchange, individual interactions through demand and supply
result in market clearing prices in a general equilibrium of all markets.
The Arrow-Debreu general equilibrium approach lists out all the con-
ditions required for the equilibrium to meet the Pareto efﬁciency criteria.
Since markets in the real world generally fail to meet all the conditions
required for equilibrium, they are generally termed as market failures.
Policy interventions in the market are therefore theoretically justiﬁed
because of market failures. Reforms are aimed at withdrawal of govern-
ment intervention either because the costs of government failure are
more than those of market failure or because the dynamics of markets in
terms of technological change and the emergence of new markets reduce
the need for the government’s intervention. An example of the latter
aspect is deregulation when technological change reduces the natural
monopoly (global economies of scale) properties of certain industries.
On the basis of Pareto optimality conditions, policy changes are sup-
posed to meet both efﬁciency and distributional criteria. On efﬁciency
grounds, policy changes should drive product and factor market prices to
reﬂect their true opportunity costs (long-run marginal costs and produc-
tivity). On distributional grounds, policy changes that make some agents
in the economy better off should not be at the cost of others. However, by
their deﬁnition, the fundamental objectives of the policy shifts in develop-
ing and transition economies are not supposed to meet the distributional
criteria at least in the short and medium term. This is because the policy
shifts are made on the assumption that the previous policy regimes gener-
ated monopolies and inefﬁciency in the allocation of resources in an
economy. The policy reforms are aimed at shifting economic activity to
competitive mode to eliminate monopoly rents so that consumers gain at
the cost of monopoly producers. Furthermore, the policy reforms also aim
at improving the allocative efﬁciency of resources. This means that some
sectors gain at the cost of others in an economy. The basic theory of com-
parative advantage shows, for example, that opening to international
trade makes protected industries contract and industries with comparative
advantage expand. Therefore, people engaged in the protected industries
lose out as a result of policy shifts. The distributional outcomes have
implications on the changing bargaining position of different groups,
which, in turn, determines the direction of institutional change.
When one goes by the pure neoclassical approach of markets as institu-
22The conceptual framework

tions, the Pareto efﬁciency criteria can result in awkward results under
certain conditions. Consider, for example, the textbook case of a perfectly
discriminating monopolist. He can be shown to be Pareto-efﬁcient
because he charges different prices from different consumers depending
on their willingness and ability to pay. The total market is served, and the
last and poorest consumer pays a price equal to marginal cost. However,
the monopolist takes away the consumer surplus. By the same logic, the
institutional arrangement of slavery or bonded labor is Pareto-efﬁcient
because a landlord pays a wage to a worker on the basis of his/her bar-
gaining power. Some ways in which these institutional arrangements can
change in a normative way are the emergence of new (or previously non-
existent) markets and a reduction in transaction costs of exchange which
improve the bargaining power of workers and consumers; for example,
there can be an increase in the number of producers, or improvements in
capital markets, which reduce the power of access to capital as a monopoly
source. To illustrate, bonded labor, an institutional arrangement quite
prevalent in rural India till recently, came about as a result of the inter-
locking of capital and labor markets, which slowly disappeared in several
parts of south India as a result of the commercialization of agriculture and
improvements in capital markets.
Drawing from the above example, efﬁciency outcomes are the primary
focus from a purely positivist approach and in normative terms distribu-
tional considerations become germane for the analysis. In the short term,
the policy reforms may result in adverse outcomes to certain sections of
the society on distributional grounds. In the long run, however, as
markets and institutions evolve, some of these adverse outcomes of distrib-
ution may be rectiﬁed and it is possible that productivity increases may
result in improvement for everyone.
The evolution of markets in response to economic reforms involves two
interrelated elements: prices (in the product and input markets)
approaching their opportunity costs, and the emergence of new markets
which were non-existent prior to the reforms. These two elements are
interrelated because Arrow-Debreu general equilibrium requires the exist-
ence of a complete set of markets for prices to reﬂect their true opportun-
ity costs in space and time. Absence of one market may block emergence
or development of other necessary markets, whereas the emergence of a
new market leads to emergence of other markets. If markets for informa-
tion emerge, it leads to greater participation of agents and expansion or
emergence of other markets. For example, the entry of large institutional
investors in India’s capital markets led to the emergence of markets for
information about India’s corporations, which, in turn, saw further devel-
opment of ﬁnancial markets.
The conceptual framework23

Economic institutions
The main concept of the new institutional economics is transaction costs
of exchange, which implies that market exchange is subject to friction, in
contrast to the neoclassical deﬁnition of markets. As discussed in the pre-
vious chapter, from Coase’s idea of transaction costs, two streams of ana-
lysis came about in the discipline of economics. One is the economics of
organization, that a signiﬁcant level of economic activity in a free market
economy is governed not only by individual free choice but also by hier-
archy of organization in order to economize on market transaction costs.
Second, the Coasian theorem of property rights (1960) shows that the
presence of transaction costs in market exchange necessitates collective
action through social arrangements of public (governments) and private
ordering to rectify the social costs of individual rational choices. Collective
action is an institutional arrangement of the governance mechanism. To
recapitulate from the previous chapter, the analytical developments in
transaction costs economics led to two interrelated issues of analyzing
institutions of capitalism – one that deals with the institutional environ-
ment (the rules of the game) (North, 1990), and the other dealing with
the institutions of governance (the playing of the game) (Williamson,
1975, 1985). The institutional environment deals with the issues of the
rules of the game, such as the property rights (polity, constitution, judi-
ciary, bureaucracy), embeddedness conditions of customs, traditions, and
norms. Economics of organization concentrates on the issues of contracts
and governance structures, with the notion of the playing of the game
under the given rules. The interplay of these two aspects determines the
economic institutions of capitalism and their evolution.
In Coase’s theory of property rights, collective action is required when
individual actions cause costs to a society at large owing to negative exter-
nalities. Collective action is socially more efﬁcient than individuals acting
in isolation. For example, a negative externality resulting out of a single
individual’s action affects a group of individuals. The sum of costs of indi-
vidual actions in isolation could be higher than the costs of collective
action in rectifying the negative externality. Collective action can take two
forms – private ordering of individuals getting together for bargaining,
and public ordering of government enforcing property rights. In the pres-
ence of high transaction costs and a high degree of individual free-riding,
individuals forming into an effective bargaining group may fail to be
effective. In this context, the emergence of public ordering through
government and legal bodies becomes pertinent. However, the issue is not
so simple in terms of understanding institutions, because there could be
several situations where transaction costs associated with the courts and
governments may be higher than private ordering solutions. In this
context, private ordering institutions may become more efﬁcient than the
public ordering institutions of governments.
24The conceptual framework

Apart from people forming into associations for repeated interactions,
social norms and trust are important elements of private ordering, which
determine relative efﬁciency of institutions of different societies or
nations. For example, throwing garbage on the streets is illegal in most
countries, but enforcing it by government is highly costly. Societies that
have developed the norm of individuals not throwing garbage end up with
lower collective costs, while societies which could not develop the norm
end up with high social costs, both in terms of the costs of the negative
externalities and the costs of monitoring and enforcing by government.
What are the boundaries of collective action of a group through social
capital? A family keeps its home very clean and throws garbage into the
streets, or a nation throws polluting industries on to other nations. In
other words, when one group can get into effective collective action it
generates surplus for the group, the surplus generation could be purely
owing to collective production (indivisibilities and specialization) or on
distributional grounds of redistributing wealth from other groups. The
latter outcome need not be monetary or direct transfers: it can take the
form that the collective action of a group results in negative externalities
to outsiders. The countervailing collective action of the outside agents
depends on the transaction costs of organizing and cohesiveness of the
group. If outside agents are diffused, their ability for collective action will
be low. In other words, in Coasian theory, individuals forming into a
group can bring out socially efﬁcient outcome through bargaining with
the polluter. In the above example, a powerful group could redistribute
wealth in their favor or impose costs of negative externalities on the less
organized, who could not undertake transaction costs of their own group
formation. This may not be socially efﬁcient.
North (1990) in his analysis of institutional environment observes that
institutions are “the humanly devised constraints that structure political,
economic, and social interactions. They consist of both informal con-
straints (sanctions, taboos, customs, traditions, and codes of conduct), and
formal rules (constitutions, laws, property rights).” These institutional
factors determine the extent of transaction costs of an economy both at
micro and aggregate levels. Societies that are able to realize lower transac-
tion costs for any speciﬁc economic activity realize higher material value
for any given resources than those societies with higher transaction costs.
In other words, the relative efﬁciency of the institutional environment
across nations and over time can be seen in terms of the extent of transac-
tion costs in individual and collective economic activity. To illustrate this
with simple examples, one can compare the transaction costs incurred by
an individual in different spheres of economic activity, say in India and
the US: for example, transaction costs to obtain a driver’s license (in
India, someone who can bribe the relevant ofﬁcer may obtain the license
with zero ‘search costs’ by incurring transaction costs of the bribe); or the
transaction costs a job-seeker has to incur and a ﬁrm incurs in hiring a
The conceptual framework25

speciﬁc skilled worker in the labor market. The higher the opportunity
costs of an economic agent, the higher is the loss of value to a society in
the presence of high market transaction costs – ‘the search costs’. As a
matter of fact, the opportunity cost of skilled labor is dampened because
of inefﬁcient institutions.
The institutional environment determines micro-level governance
choices of private agents, which, in turn, determine the economic efﬁciency
of a society. For example, if property rights and enforcement of contracts
are weak, and information is highly imperfect, transaction costs will be high
and the magnitude of transactions will be low, resulting in inefﬁcient gover-
nance choices. As Coase’s paper on ‘The Nature of the Firm’ suggested,
one of the ways of mitigating transaction costs of market exchange is to
internalize economic activity into an organization, and internalization has
its costs of bureaucracy. High transaction costs of markets result in excess
integration, which means economic loss through the costs of bureaucracy,
apart from loss of beneﬁts through division of labor.
Here, the issue is what are the differential transaction costs. Although
Coase put forward powerful arguments for the relevance of transaction
costs in two of his famous papers, he did not bring forth speciﬁc elements
of transaction costs, which, in turn, led to the criticism by mainstream
economists that everything can be termed a transaction cost. Williamson,
in a series of inﬂuential papers, formalized different elements and the
nature of transaction costs and their implications for governance choices.
Williamson conceptualizes differential transaction costs through the
lens of the science of contracts and shows how they result in differential
governance structures. In his schema, transaction costs differ in three crit-
ical dimensions – frequency, uncertainty, and asset speciﬁcity. Asset speci-
ﬁcity has a strong contractual dimension. All contracts are incomplete: it
is literally impossible for agents to foresee all possible contingencies and
incorporate them into contracts. Williamson makes two main behavioral
assumptions – bounded rationality and opportunistic behavior. Bounded
rationality, following Simon (1957), refers to behavior intendedly rational,
but limitedly so owing to both informational asymmetry and cognitive abil-
ities. This makes the notion of incomplete contracts logically consistent.
The opportunistic behavior is seen in terms of self-interest with guile.
Guile, basically, implies that, when contracts are incomplete, agents
renege on promises when it suits their purposes.
1
In the ex ante contrac-
tual stage, the market is competitive. Once two agents get into a contract
for an economic activity, it becomes a bilateral monopoly (bargaining). In
the context of incomplete contracts, agents can behave opportunistically
when the environment changes in their favor in the ex post contractual
stage. The costs of the opportunistic behavior are high when the agents
have to invest in assets with low redeployable properties – these are assets
that are very speciﬁc to an economic activity but have low economic value
in other uses.
26The conceptual framework

The behavioral assumption of opportunism is effective to understand
the generation of institutional conditions that mitigate the costs of oppor-
tunistic behavior of economic agents. At the micro level, it refers to incor-
poration of contractual safeguards at the ex ante stage, and at the macro
level, it refers to adoption of formal laws and regulation that protect the
larger section of society from the costs of the opportunism of powerful
agents. To illustrate the latter point, in the case of stock markets, man-
agers and large investors may have more inside information than a large
number of dispersed investors. In the absence of effective laws and regula-
tion, the powerful agents can behave opportunistically, resulting in heavy
costs to the larger sections. This was the case in the early and the mid-
1990s in India, when a couple of stock market scams took place. Several
bogus companies raised capital in the equity market and vanished.
Given the differential transaction costs of different economic activities,
economic agents choose among different governance structures –
markets, ﬁrms, hybrids, and public bureaus. They represent different costs
and beneﬁts in relation to the transaction costs of contracts and exchange
under uncertainty. The alignment of property rights and their enforce-
ment by government agencies or by private ordering is determined by
transaction costs. If enforcement of property rights involves high transac-
tion costs to individuals, the public bureaus are more efﬁcient. However,
enforcement through public bureaus like courts and government bodies
also involves transaction costs to individuals and the additional costs of the
bureaucracy of the public bureaus. Here, one has to examine the trade-
offs between the two governance structures (public bureau and private
ordering) for economic efﬁciency considerations. For example, a contrac-
tual dispute can be settled through courts or through mutual negotiations
by weighing legal costs to the concerned parties. This logic can be
extended to explain the functioning of government, and even the maﬁa,
as a forced social arrangement by an organized group.
What is the difference between the maﬁa and government as institu-
tions of public or private ordering? In the advanced capitalist societies of
the West, government is seen as a result of democratic collective action.
Arrows (1951) ‘impossibility theorem’ in the social choice literature has
shown us that however hard we try, it is not possible for the collective-
action-based rules to reﬂect each individual’s preferences perfectly. The
larger the group, the more difﬁcult it is. Individuals whose preferences are
not reﬂected in the formal rules either accept their being worse off or
ﬁnd ways to break the rules. Thus, imposition of prohibition of consump-
tion of alcohol in the US in the 1920s and 1930s and the black market for
gold in India in the pre-reform period both led to emergence of the
maﬁa. This is one form of the maﬁa as a private ordering that caters to
those individuals whose preferences are left out of the rules of the public
ordering. While individuals can operate a black market, the maﬁa is an
organization. A maﬁa is a small, organized group imposing rules on the
The conceptual framework27

unorganized, in a manner similar to dictatorships. They are de facto gov-
ernments of forced governance, whose internal organization, rules and
methods of deriving revenues depend on a given social and economic
environment, discussion of which is beyond the scope of the present work.
One of the possible ways to increase the degree of individuals’ choices
reﬂected in collective-action-based rules is to build governance of public
ordering institutions from the bottom up of decentralized government
structure.
2
In other words, smaller groups’ participation has a higher
probability of each individual’s preferences getting a higher degree of
reﬂection in the policy formulation than large groups’ participation. I
brieﬂy discuss the issues related to formal rules (public ordering) in the
following.
Formal rules and laws
In small societies in which everybody knows everybody else, with a dense
network of interaction, transaction costs are low as most economic
exchanges do not need formal contracts. Cheating and opportunistic
behaviour are restrained because of the penalties of social stigma.
However, in these societies production costs are high because of the small-
scale organization of production. Once economic activity becomes large-
scale and complex through division of labor, it results in the emergence of
large group and anonymous (one-shot) interactions. Taking from Adam
Smith, North (1989) observes, “Increasing specialization and division of
labor necessitates the development of institutional structures that permit
individuals to take actions involving complex relationships with other indi-
viduals far removed from any personal knowledge and extending over a
long period of time.” This results in the increased need for formal rules
and contracts to enable large group interactions to reduce costs of cheat-
ing and opportunism. This is when the importance of the rules deﬁned
and enforced by the governments becomes imperative for the economic
efﬁciency of the exchange mechanism. Countries that have developed
better deﬁnition of the rules and better mechanisms of enforcement by
the state will have lower transaction costs for a similar transaction.
There are two dimensions to formal rules: one is the deﬁnition of the
rules (the laws), and the other is enforcement, with the two being inter-
related in determining the efﬁciency of an outcome. The deﬁnition of the
rules is similar to designing an organization (they can be copied from
other societies). Enforcement of rules involves institutional effectiveness
(embeddedness). The transaction costs of enforcement determine the
efﬁciency of the outcome. When laws are poorly deﬁned, they give discre-
tionary powers to government and government agents to change and
enforce them at will. This discourages private agents from investing in
durable assets for fear of appropriation. Furthermore, government agents
can act as predators, extracting bribes. This again results in both high
28The conceptual framework

transaction costs and uncertainty for investors. Even if the laws are well
deﬁned, mechanisms of enforcement can be weak: the enforcement
mechanism involves the costs of monitoring and information, delegation
under agency relations, and the transaction costs of courts. India, for
example, has one of the ﬁnest and most elaborately deﬁned laws for pro-
tecting the environment but their enforcement has been quite weak. On
the other hand, the US, despite having fewer laws, has effective enforce-
ment with the end result of better protection of the environment.
Enforcement may involve monitoring and initiation of legal cases, both by
government and private agents. A private agent can go to the court if the
laws are broken either by government or other private agents. The latter
aspect stems from the ability of private agents to incur transaction costs
and undertake collective action.
Although the Western capitalist countries have a broadly similar legal
framework of capitalism, the underlying features of emergence and
enforcement of laws are different in different countries, which is partly
traceable to their economic history. The differences in the legal frame-
work have implications for the economic efﬁciency of the rules, especially
in their enforcement. In the common-law countries, laws emanate from
judicial decisions. In the civil-law countries, they emanate from the center.
Although, several elements among the two are similar – for example the
limited liability system in the ﬁnancial markets emerged in the common-
law countries ﬁrst and was later copied by the civil-law countries – the
processes differ. It is easier for new laws to be enacted by the civil-law
countries because of the centralization of powers. The capture of the
government by the vested interest groups is higher in the civil-law coun-
tries than in the common-law countries (Rajan and Zingales, 2003). This
issue is, however, rather blurred because when courts in the US imple-
mented the regulation in the nineteenth century, it was subverted by big
business, which obliged government to usurp the main role in regulation
(Glaeser and Shleifer, 2003).
Similarly, the centralized versus decentralized governance structures
determine the effectiveness of enforcement of laws. Under the centralized
structure, there could be a higher amount of informational imperfections,
which may give a high degree of discretionary powers to the government
agents at the bottom. Furthermore, there could be a high degree of moral
hazard behavior on the part of public agents under centralization because
of the distance between the governed and the government.
Credible commitments of government actions to given rules and laws,
such that the government does not have too many discretionary powers to
change rules, depend on the extent of centralization of legislative and
executive powers. For example, under the parliamentarian system of the
UK and India, the government (executive) controls the legislative process.
In the presidential system of the US, the president does not have full
control over the legislative process. Here, the legislature tends to impose
The conceptual framework29

much stronger procedural burdens on the executive branch to limit the
deviations from legislators’ interests. The discretionary powers of govern-
ment are higher under the parliamentarian system than in the presiden-
tial system. Low credible commitments of governments discourage private
agents from investing in durable and sunk-cost intensive assets, which is
basically a form of mitigation of property rights (Levy and Spiller, 1996;
Williamson, 1998).
Formal rules of property rights
Under capitalism, private property right is an important institutional con-
dition based on the premise that private ownership provides the right
incentives in utilizing resources efﬁciently, while common ownership can
result in the tragedy of commons-people free-riding and causing degrada-
tion of resources. The issue of property rights under capitalism is subject
to complex deﬁnitions because several resources have common property
properties. To give a simple example, a private agent can own a piece of
land but groundwater is basically a common property. A single person’s
misuse of groundwater can result in negative externalities to others and
everybody becomes worse off. The management of private and public
property in different spheres is done both by elaborately deﬁned and
enforced rules of governments and by evolved social norms of societies.
A well-deﬁned property rights system reﬂects a set of entitlements that
deﬁne owners’ privileges and obligations regarding the use of a resource.
It is expected to have the following general features:
• Comprehensively assigned – all resources are either collectively or pri-
vately owned and all entitlements are known and enforced.
• Exclusive – owners internalize all beneﬁts and costs from the use of a
resource.
• Transferable – all property rights should be transferable in voluntary
exchange with minimum transaction costs.
• Secure – property rights should be safeguarded/protected from invol-
untary seizure or encroachment by other private agents and govern-
ments.
The modern property rights approach of Grossman and Hart (1986) and
Hart and Moore (1990), which draws from Williamson’s theory of incom-
plete contracts, refers to the organization of collective effort and incen-
tives of economic agents. This approach looks at the ﬁrm as a set of
property rights and focuses on the role of physical assets in contractual
relationship. Two agents, say AandB, with human and physical capital
have the incentive to enter into a contract for joint production if combin-
ing their assets results in higher surplus value than each working indepen-
dently of the other. In other words, the assets in consideration have
30The conceptual framework

complementarity properties. As contracts are invariably incomplete, each
one has residual rights in using his or her own physical assets arising out
of the conditions not speciﬁed in the contract. Ownership of physical
assets is the source of control rights. The incentive for Ato buy Bis to
take over the residual rights of BwhenAneedsBto increase investments
in the relationship speciﬁc assets but Bhas low incentives in undertaking
the investment. Merger gives Afull control over all the physical assets for
production. The merging outcome is determined by the incentives of
agents before and after the merger in undertaking investments and
sharing the surplus value. A’s having full control rights after the merger is
the source of higher surplus to A, which, in turn, reduces the surplus and
alters the incentives of Bwithin the merged ﬁrm. The control rights of A
give him or her power in assigning tasks to workers and ﬁring them
(denying them the opportunity to work with the physical assets of the
ﬁrm).
Some of the possible disputes and the issue of control rights under
incomplete contracts can be illustrated by the following story from India’s
Panchatantra (children’s story book):
On a hot summer day a traveler hired a donkey to carry him across a
dusty road to the next town. The owner of the donkey walked along to
bring the donkey back after the journey. In the middle of the day, the
traveler wanted to shelter from the heat. As there was no other shade,
he sat under the shadow of the donkey. The donkey’s owner also
wanted to rest and had the same idea of using the shade provided by
the donkey. He said to the traveler, “The donkey is mine and you
hired only the donkey but said nothing about the shadow of the
donkey. So let me sit in the shade of the donkey.” The traveler
replied, “I hired the donkey for the day and you cannot separate the
shadow from the donkey.” As the two men quarreled, the donkey ran
off. The moral of the story is that if one ﬁghts over the shadow, one
may lose the substance.
In the present context, the story is an illustration of the hazards inherent
in incomplete contracts.
According to modern property rights literature, establishing property
rights means enforcing the contracts through which economic agents try
to arrive at efﬁcient control structures or ﬁnding ways to improve the efﬁ-
ciency of control rights. As implicit in the previous observations, efﬁciency
of control rights involves incentives of agents in a contract to undertake
investments and efﬁcient utilization of physical assets. The issue of control
rights can be applied to a broad spectrum of economic activity, such as the
separation of ownership and control of capital of public limited com-
panies, ﬁnancial institutions, and government policies. For example, if
there is imperfect or asymmetric information under agency relations
The conceptual framework31

Other documents randomly have
different content

Nearer and nearer came the supposed herd. The chief lay very still, ready
to shoot when it came within range. Suddenly he saw, to his horror, that
what approached them was a huge snake with a rattle as large as a man's
head. Though almost paralysed with surprise and terror, he managed to
shoot the monster and kill it. He called up his men, who were not a little
afraid of the gigantic creature, even though it was dead, and for a long time
they debated what they should do with the carcass. At length hunger
conquered their scruples and made them decide to cook and eat it. To their
surprise, they found the meat as savoury as that of a buffalo, which it much
resembled. All partook of the fare, with the exception of one boy, who
persisted in refusing it, though they pressed him to eat.
When the warriors had finished their meal they lay down beside the
camp-fire and fell asleep. Later in the night the chief awoke and was
horrified to find that his companions had turned to snakes, and that he
himself was already half snake, half man. Hastily he gathered his
transformed warriors, and they saw that the boy who had not eaten of the
reptile had retained his own form. The lad, fearing that the serpents might
attack him, began to weep, but the snake-warriors treated him very kindly,
giving him their charms and all they possessed.
At their request he put them into a large robe and carried them to the
summit of a high hill, where he set them down under the trees.
"You must return to our lodges," they told him, "and in the summer we
will visit our kindred. See that our wives and children come out to greet us."
The boy carried the news to his village, and there was much weeping
and lamentation when the friends of the warriors heard of their fate. But in
the summer the snakes came and sat in a group outside the village, and all
the people crowded round them, loudly venting their grief. The horses
which had belonged to the snakes were brought out to them, as well as their
moccasins, leggings, whips, and saddles.
"Do not be afraid of them," said the boy to the assembled people. "Do
not flee from them, lest something happen to you also." So they let the
snakes creep over them, and no harm befell. In the winter the snakes

vanished altogether, and with them their horses and other possessions, and
the people never saw them more.
The Three Tests
There dwelt in a certain village a woman of remarkable grace and
attractiveness. The fame of her beauty drew suitors from far and near, eager
to display their prowess and win the love of this imperious creature—for,
besides being beautiful, she was extremely hard to please, and set such tests
for her lovers as none had ever been able to satisfy.
A certain young man who lived at a considerable distance had heard of
her great charms, and made up his mind to woo and win her. The difficulty
of the task did not daunt him, and, full of hope, he set out on his mission.
As he travelled he came to a very high hill, and on the summit he saw a
man rising and sitting down at short intervals. When the prospective suitor
drew nearer he observed that the man was fastening large stones to his
ankles. The youth approached him, saying: "Why do you tie these great
stones to your ankles?"
"Oh," replied the other, "I wish to chase buffaloes, and yet whenever I do
so I go beyond them, so I am tying stones to my ankles that I may not run
so fast."
"My friend," said the suitor, "you can run some other time. In the
meantime I am without a companion: come with me."
The Swift One agreed, and they walked on their way together. Ere they
had gone very far they saw two large lakes. By the side of one of them sat a
man, who frequently bowed his head to the water and drank. Surprised that
his thirst was not quenched, they said to him: "Why do you sit there
drinking of the lake?"

"I can never get enough water. When I have finished this lake I shall start
on the other."
"My friend," said the suitor, "do not trouble to drink it just now. Come
and join us."
The Thirsty One complied, and the three comrades journeyed on. When
they had gone a little farther they noticed a man walking along with his face
lifted to the sky. Curious to know why he acted thus, they addressed him.
"Why do you walk with your eyes turned skyward?" said they.
"I have shot an arrow," he said, "and I am waiting for it to reappear."
"Never mind your arrow," said the suitor. "Come with us."
"I will come," said the Skilful Archer.
As the four companions journeyed through a forest they beheld a strange
sight. A man was lying with his ear to the ground, and if he lifted his head
for a moment he bowed it again, listening intently. The four approached
him, saying: "Friend, for what do you listen so earnestly?"
"I am listening," said he, "to the plants growing. This forest is full of
plants, and I am listening to their breathing."
"You can listen when the occasion arises," they told him. "Come and join
us."
He agreed, and so they travelled to the village where dwelt the beautiful
maiden.
When they had reached their destination they were quickly surrounded
by the villagers, who displayed no small curiosity as to who their visitors
were and what object they had in coming so far. When they heard that one
of the strangers desired to marry the village beauty they shook their heads
over him. Did he not know the difficulties in the way? Finding that he
would not be turned from his purpose, they led him to a huge rock which

overshadowed the village, and described the first test he would be required
to meet.
"If you wish to win the maiden," they said, "you must first of all push
away that great stone. It is keeping the sunlight from us."
"Alas!" said the youth, "it is impossible."
"Not so," said his companion of the swift foot; "nothing could be more
easy."

"He leaned his shoulder against the rock"

Saying this, he leaned his shoulder against the rock, and with a mighty
crash it fell from its place. From the breaking up of it came the rocks and
stones that are scattered over all the world.
The second test was of a different nature. The people brought the
strangers a large quantity of food and water, and bade them eat and drink.
Being very hungry, they succeeded in disposing of the food, but the suitor
sorrowfully regarded the great kettles of water.
"Alas!" said he, "who can drink up that?"
"I can," said the Thirsty One, and in a twinkling he had drunk it all.
The people were amazed at the prowess of the visitors. However, they
said, "There is still another test," and they brought out a woman who was a
very swift runner, so swift that no one had ever outstripped her in a race.
The Race
"You must run a race with this woman," said they. "If you win you shall
have the hand of the maiden you have come to seek."
Naturally the suitor chose the Swift One for this test. When the runners
were started the people hailed them as fairly matched, for they raced
together till they were out of sight.
When they reached the turning-point the woman said: "Come, let us rest
for a little."
The man agreed, but no sooner had he sat down than he fell asleep. The
woman seized her opportunity. Making sure that her rival was sleeping
soundly, she set off for the village, running as hard as she could.
Meanwhile the four comrades were anxiously awaiting the return of the
competitors, and great was their disappointment when the woman came in
sight, while there was yet no sign of their champion.

The man who could hear the plants growing bent his ear to the ground.
"He is asleep," said he; "I can hear him snoring."
The Skilful Archer came forward, and as he bit the point off an arrow he
said: "I will soon wake him."
He shot an arrow from the bowstring with such a wonderful aim that it
wounded the sleeper's nose, and roused him from his slumbers. The runner
started to his feet and looked round for the woman. She was gone. Knowing
that he had been tricked, the Swift One put all his energy into an effort to
overtake her. She was within a few yards of the winning-post when he
passed her. It was a narrow margin, but nevertheless the Swift One had
gained the race for his comrade.
The youth was then married to the damsel, whom he found to be all that
her admirers had claimed, and more.
The Snake-Ogre
One day a young brave, feeling at variance with the world in general,
and wishing to rid himself of the mood, left the lodges of his people and
journeyed into the forest. By and by he came to an open space, in the centre
of which was a high hill. Thinking he would climb to the top and
reconnoitre, he directed his footsteps thither, and as he went he observed a
man coming in the opposite direction and making for the same spot. The
two met on the summit, and stood for a few moments silently regarding
each other. The stranger was the first to speak, gravely inviting the young
brave to accompany him to his lodge and sup with him. The other accepted
the invitation, and they proceeded in the direction the stranger indicated.
On approaching the lodge the youth saw with some surprise that there
was a large heap of bones in front of the door. Within sat a very old woman
tending a pot. When the young man learned that the feast was to be a
cannibal one, however, he declined to partake of it. The woman thereupon

boiled some corn for him, and while doing so told him that his host was
nothing more nor less than a snake-man, a sort of ogre who killed and ate
human beings. Because the brave was young and very handsome the old
woman took pity on him, bemoaning the fate that would surely befall him
unless he could escape from the wiles of the snake-man.
"Listen," said she: "I will tell you what to do. Here are some moccasins.
When the morning comes put them on your feet, take one step, and you will
find yourself on that headland you see in the distance. Give this paper to the
man you will meet there, and he will direct you further. But remember that
however far you may go, in the evening the Snake will overtake you. When
you have finished with the moccasins take them off, place them on the
ground facing this way, and they will return."
"Is that all?" said the youth.
"No," she replied. "Before you go you must kill me and put a robe over
my bones."
The Magic Moccasins
The young brave forthwith proceeded to carry these instructions into
effect. First of all he killed the old woman, and disposed of her remains in
accordance with her bidding. In the morning he put on the magic moccasins
which she had provided for him, and with one great step he reached the
distant headland. Here he met an old man, who received the paper from
him, and then, giving him another pair of moccasins, directed him to a far-
off point where he was to deliver another piece of paper to a man who
would await him there. Turning the first moccasins homeward, the young
brave put the second pair to use, and took another gigantic step. Arrived at
the second stage of his journey from the Snake's lodge, he found it a
repetition of the first. He was directed to another distant spot, and from that
to yet another. But when he delivered his message for the fourth time he
was treated somewhat differently.

"With one great step he reached the distant headland"

"Down there in the hollow," said the recipient of the paper, "there is a
stream. Go toward it, and walk straight on, but do not look at the water."
The youth did as he was bidden, and shortly found himself on the
opposite bank of the stream.
He journeyed up the creek, and as evening fell he came upon a place
where the river widened to a lake. Skirting its shores, he suddenly found
himself face to face with the Snake. Only then did he remember the words
of the old woman, who had warned him that in the evening the Snake would
overtake him. So he turned himself into a little fish with red fins, lazily
moving in the lake.
The Snake's Quest
The Snake, high on the bank, saw the little creature, and cried: "Little
Fish! have you seen the person I am looking for? If a bird had flown over
the lake you must have seen it, the water is so still, and surely you have
seen the man I am seeking?"
"Not so," replied the Little Fish, "I have seen no one. But if he passes
this way I will tell you."
So the Snake continued down-stream, and as he went there was a little
grey toad right in his path.
"Little Toad," said he, "have you seen him for whom I am seeking? Even
if only a shadow were here you must have seen it."
"Yes," said the Little Toad, "I have seen him, but I cannot tell you which
way he has gone."
The Snake doubled and came back on his trail. Seeing a very large fish
in shallow water, he said: "Have you seen the man I am looking for?"

"That is he with whom you have just been talking," said the Fish, and the
Snake turned homeward. Meeting a musk-rat he stopped.
"Have you seen the person I am looking for?" he said. Then, having his
suspicions aroused, he added craftily: "I think that you are he."
But the Musk-rat began a bitter complaint.
"Just now," said he, "the person you seek passed over my lodge and
broke it."
So the Snake passed on, and encountered a red-breasted turtle.
He repeated his query, and the Turtle told him that the object of his
search was to be met with farther on.
"But beware," he added, "for if you do not recognize him he will kill
you."
Following the stream, the Snake came upon a large green frog floating in
shallow water.
"I have been seeking a person since morning," he said. "I think that you
are he."
The Frog allayed his suspicions, saying: "You will meet him farther
down the stream."
The Snake next found a large turtle floating among the green scum on a
lake. Getting on the Turtle's back, he said: "You must be the person I seek,"
and his head rose higher and higher as he prepared to strike.
"I am not," replied the Turtle. "The next person you meet will be he. But
beware, for if you do not recognize him he will kill you."
When he had gone a little farther down the Snake attempted to cross the
stream. In the middle was an eddy. Crafty as he was, the Snake failed to
recognize his enemy, and the eddy drew him down into the water and

drowned him. So the youth succeeded in slaying the Snake who had sought
throughout the day to kill him.
The Story of the Salmon
A certain chief who had a very beautiful daughter was unwilling to part
with her, but knowing that the time must come when she would marry he
arranged a contest for her suitors, in which the feat was to break a pair of
elk's antlers hung in the centre of the lodge.
"Whoever shall break these antlers," the old chief declared, "shall have
the hand of my daughter."
The quadrupeds came first—the Snail, Squirrel, Otter, Beaver, Wolf,
Bear, and Panther; but all their strength and skill would not suffice to break
the antlers. Next came the Birds, but their efforts also were unavailing. The
only creature left who had not attempted the feat was a feeble thing covered
with sores, whom the mischievous Blue Jay derisively summoned to
perform the task. After repeated taunts from the tricky bird, the creature
rose, shook itself, and became whole and clean and very good to look upon,
and the assembled company saw that it was the Salmon. He grasped the
elk's antlers and easily broke them in five pieces. Then, claiming his prize,
the chief's daughter, he led her away.
Before they had gone very far the people said: "Let us go and take the
chief's daughter back," and they set off in pursuit of the pair along the sea-
shore.
When Salmon saw what was happening he created a bay between
himself and his pursuers. The people at length reached the point of the bay
on which Salmon stood, but he made another bay, and when they looked
they could see him on the far-off point of that one. So the chase went on, till
Salmon grew tired of exercising his magic powers.

Coyote and Badger, who were in advance of the others, decided to shoot
at Salmon. The arrow hit him in the neck and killed him instantly. When the
rest of the band came up they gave the chief's daughter to the Wolves, and
she became the wife of one of them.
In due time the people returned to their village, and the Crow, who was
Salmon's aunt, learnt of his death. She hastened away to the spot where he
had been killed, to seek for his remains, but all she could find was one
salmon's egg, which she hid in a hole in the river-bank. Next day she found
that the egg was much larger, on the third day it was a small trout, and so it
grew till it became a full-grown salmon, and at length a handsome youth.
Salmon's Magic Bath
Leading young Salmon to a mountain pool, his grand-aunt said: "Bathe
there, that you may see spirits."
One day Salmon said: "I am tired of seeing spirits. Let me go away."
The old Crow thereupon told him of his father's death at the hands of
Badger and Coyote.
"They have taken your father's bow," she said.
The Salmon shot an arrow toward the forest, and the forest went on fire.
He shot an arrow toward the prairie, and it also caught fire.
"Truly," muttered the old Crow, "you have seen spirits."
Having made up his mind to get his father's bow, Salmon journeyed to
the lodge where Coyote and Badger dwelt. He found the door shut, and the
creatures with their faces blackened, pretending to lament the death of old
Salmon. However, he was not deceived by their tricks, but boldly entered
and demanded his father's bow. Four times they gave him other bows,
which broke when he drew them. The fifth time it was really his father's

bow he received. Taking Coyote and Badger outside, he knocked them
together and killed them.
The Wolf Lodge
As he travelled across the prairie he stumbled on the habitation of the
Wolves, and on entering the lodge he encountered his father's wife, who
bade him hide before the monsters returned. By means of strategy he got
the better of them, shot them all, and sailed away in a little boat with the
woman. Here he fell into a deep sleep, and slept so long that at last his
companion ventured to wake him. Very angry at being roused, he turned her
into a pigeon and cast her out of the boat, while he himself, as a salmon,
swam to the shore. Near the edge of the water was a lodge, where dwelt five
beautiful sisters. Salmon sat on the shore at a little distance, and took the
form of an aged man covered with sores. When the eldest sister came down
to speak to him he bade her carry him on her back to the lodge, but so
loathsome a creature was he that she beat a hasty retreat. The second sister
did likewise, and the third, and the fourth. But the youngest sister proceeded
to carry him to the lodge, where he became again a young and handsome
brave. He married all the sisters, but the youngest was his head-wife and his
favourite.
The Drowned Child
On the banks of a river there dwelt a worthy couple with their only son,
a little child whom they loved dearly. One day the boy wandered away from
the lodge and fell into the water, and no one was near enough to rescue him.
Great was the distress of the parents when the news reached them, and all
his kindred were loud in their lamentations, for the child had been a
favourite with everybody. The father especially showed signs of the deepest
grief, and refused to enter his lodge till he should recover the boy. All night
he lay outside on the bare ground, his cheek pillowed on his hand. Suddenly

he heard a faint sound, far under the earth. He listened intently: it was the
crying of his lost child! Hastily he gathered all his relatives round him, told
them what he had heard, and besought them piteously to dig into the earth
and bring back his son. This task they hesitated to undertake, but they
willingly collected horses and goods in abundance, to be given to any one
who would venture.
Two men came forward who claimed to possess supernatural powers,
and to them was entrusted the work of finding the child. The grateful father
gave them a pipe filled with tobacco, and promised them all his possessions
if their mission should succeed. The two gifted men painted their bodies,
one making himself quite black, the other yellow. Going to the
neighbouring river, they plunged into its depths, and so arrived at the abode
of the Water-god. This being and his wife, having no children of their own,
had adopted the Indian's little son who was supposed to have been drowned,
and the two men, seeing him alive and well, were pleased to think that their
task was as good as accomplished.

"They arrived at the abode of the Water-god"

"The father has sent for his son," they said. "He has commanded us to
bring him back. We dare not return without him."
"You are too late," responded the Water-god. "Had you come before he
had eaten of my food he might safely have returned with you. But he
wished to eat, and he has eaten, and now, alas! he would die if he were
taken out of the water."[1]
[1] See p. 129, "The Soul's Journey."
Sorrowfully the men rose to the surface and carried the tidings to the
father.
"Alas!" they said, "he has eaten in the palace of the Water-god. He will
die if we bring him home."
Nevertheless the father persisted in his desire to see the child.
"I must see him," he said, and the two men prepared for a second
journey, saying: "If you get him back, the Water-god will require a white
dog in payment."
The Indian promised to supply the dog. The two men painted themselves
again, the one black, the other yellow. Once more they dived through the
limpid water to the palace of the god.
"The father must have his child," they said. "This time we dare not return
without him."
So the deity gave up the little boy, who was placed in his father's arms,
dead. At the sight the grief of his kindred burst out afresh. However, they
did not omit to cast a white dog into the river, nor to pay the men lavishly,
as they had promised.

Later the parents lost a daughter in the same manner, but as she had
eaten nothing of the food offered her under the water she was brought back
alive, on payment by her relatives of a tribute to the Water-god of four
white-haired dogs.
The Snake-Wife
A certain chief advised his son to travel. Idling, he pointed out, was not
the way to qualify for chieftainship.
"When I was your age," said he, "I did not sit still. There was hard work
to be done. And now look at me: I have become a great chief."
"I will go hunting, father," said the youth. So his father furnished him
with good clothing, and had a horse saddled for him.
The young man went off on his expedition, and by and by fell in with
some elk. Shooting at the largest beast, he wounded it but slightly, and as it
dashed away he spurred his horse after it. In this manner they covered a
considerable distance, till at length the hunter, worn out with thirst and
fatigue, reined in his steed and dismounted. He wandered about in search of
water till he was well-nigh spent, but after a time he came upon a spring,
and immediately improvised a song of thanksgiving to the deity, Wakanda,
who had permitted him to find it. His rejoicing was somewhat premature,
however, for when he approached the spring a snake started up from it. The
youth was badly scared, and retreated to a safe distance without drinking. It
seemed as though he must die of thirst after all. Venturing to look back after
a time, he saw that the snake had disappeared, and very cautiously he
returned. Again the snake darted from the water, and the thirsty hunter was
forced to flee. A third return to the spring had no happier results, but when
his thirst drove him to a fourth attempt the youth found, instead of a snake,
a very beautiful woman. She offered him a drink in a small cup, which she
replenished as often as he emptied it. So struck was he by her grace and
beauty that he promptly fell in love with her. When it was time for him to

return home she gave him a ring, saying: "When you sit down to eat, place
this ring on a seat and say, 'Come, let us eat,' and I will come to you."
Having bidden her farewell, the young man turned his steps homeward,
and when he was once more among his kindred he asked that food might be
placed before him. "Make haste," said he, "for I am very hungry."
Quickly they obeyed him, and set down a variety of dishes. When he
was alone the youth drew the ring from his finger and laid it on a seat.
"Come," he said, "let us eat."
Immediately the Snake-woman appeared and joined him at his meal.
When she had eaten she vanished as mysteriously as she had come, and the
disconsolate husband (for the youth had married her) went out of the lodge
to seek her. Thinking she might be among the women of the village, he said
to his father: "Let the women dance before me."
An old man was deputed to gather the women together, but not one of
them so much as resembled the Snake-woman.
Again the youth sat down to eat, and repeated the formula which his
wife had described to him. She ate with him as before, and vanished when
the meal was over.
"Father," said the young man, "let the very young women dance before
me."
But the Snake-woman was not found among them either.
Another fleeting visit from his wife induced the chief's son to make yet
another attempt to find her in the community.
"Let the young girls dance," he said. Still the mysterious Snake-woman
was not found.
One day a girl overheard voices in the youth's lodge, and, peering in,
saw a beautiful woman sharing his meal. She told the news to the chief, and

it soon became known that the chief's son was married to a beautiful
stranger.
The youth, however, wished to marry a woman of his own tribe; but the
maiden's father, having heard that the young man was already married, told
his daughter that she was only being made fun of.
So the girl had nothing more to do with her wooer, who turned for
consolation to his ring. He caused food to be brought, and placed the ring
on a seat.
The Ring Unavailing
"Come," he said, "let us eat."
There was no response; the Snake-woman would not appear.
The youth was greatly disappointed, and made up his mind to go in
search of his wife.
"I am going a-hunting," said he, and again his father gave him good
clothes and saddled a horse for him.
When he reached the spot where the Snake-woman had first met him, he
found her trail leading up to the spring, and beyond it on the other side. Still
following the trail, he saw before him a very dilapidated lodge, at the door
of which sat an old man in rags. The youth felt very sorry for the tattered
old fellow, and gave him his fine clothes, in exchange for which he received
the other's rags.
"You think you are doing me a good turn," said the old man, "but it is I
who am going to do you one. The woman you seek has gone over the Great
Water. When you get to the other shore talk with the people you shall meet
there, and if they do not obey you send them away."

In addition to the tattered garments, the old man gave him a hat, a sword,
and a lame old horse.
At the edge of the Great Water the youth prepared to cross, while his
companion seated himself on the shore, closed his eyes, and recited a spell.
In a moment the young man found himself on the opposite shore. Here he
found a lodge inhabited by two aged Thunder-men, who were apparently
given to eating human beings. The young stranger made the discovery that
his hat rendered him invisible, and he was able to move unseen among the
creatures. Taking off his hat for a moment, he took the pipe from the lips of
a Thunder-man and pressed it against the latter's hand.
"Oh," cried the Thunder-man, "I am burnt!"
But the youth had clapped on his hat and disappeared.
"It is not well," said the Thunder-man gravely. "A stranger has been here
and we have let him escape. When our brother returns he will not believe us
if we tell him the man has vanished."
Shortly after this another Thunder-man entered with the body of a man
he had killed. When the brothers told him their story he was quite sceptical.
"If I had been here," said he, "I would not have let him escape."
As he spoke the youth snatched his pipe from him and pressed it against
the back of his hand.
"Oh," said the Thunder-man, "I am burnt!"
"It was not I," said one brother.
"It was not I," said the other.
"It was I," said the youth, pulling off his hat and appearing among them.
"What were you talking about among yourselves? Here I am. Do as you
said."
But the Thunder-men were afraid.

"We were not speaking," they said, and the youth put on his hat and
vanished.
"What will our brother say," cried the three in dismay, "when he hears
that a man has been here and we have not killed him? Our brother will
surely hate us."
In a few minutes another Thunder-man came into the lodge, carrying the
body of a child. He was very angry when he heard that they had let a man
escape.
The youth repeated his trick on the new-comer—appeared for a moment,
then vanished again. The fifth and last of the brothers was also deceived in
the same manner.
Seeing that the monsters were now thoroughly frightened, the young
man took off his magic hat and talked with them.
The Finding of the Snake-Wife
"You do wrong," said he, "to eat men like this. You should eat buffaloes,
not men. I am going away. When I come back I will visit you, and if you are
eating buffaloes you shall remain, but if you are eating men I shall send you
away."
The Thunder-men promised they would eat only buffaloes in future, and
the young man went on his way to seek for the Snake-woman. When at last
he came to the village where she dwelt he found she had married a man of
another tribe, and in a great rage he swung the sword the magician had
given him and slew her, and her husband, and the whole village, after which
he returned the way he had come. When he reached the lodge of the
Thunder-men he saw that they had not kept their promise to eat only
buffaloes.

"I am going to send you above," he said. "Hitherto you have destroyed
men, but when I have sent you away you shall give them cooling rain to
keep them alive."
So he sent them above, where they became the thunder-clouds.
Proceeding on his journey, he again crossed the Great Water with a
single stride, and related to the old wizard all that had happened.
"I have sent the Thunder-men above, because they would not stop eating
men. Have I done well?"
"Very well."
"I have killed the whole village where the Snake-woman was, because
she had taken another husband. Have I done well?"
"Very well. It was for that I gave you the sword."
The youth returned to his father, and married a very beautiful woman of
his own village.
A Subterranean Adventure
There lived in a populous village a chief who had two sons and one
daughter, all of them unmarried. Both the sons were in the habit of joining
the hunters when they went to shoot buffaloes, and on one such occasion a
large animal became separated from the herd. One of the chief's sons
followed it, and when the pursuit had taken him some distance from the rest
of the party the buffalo suddenly disappeared into a large pit. Before they
could check themselves man and horse had plunged in after him. When the
hunters returned the chief was greatly disturbed to learn that his son was
missing. He sent the criers in all directions, and spared no pains to get news
of the youth.

"If any person knows the whereabouts of the chiefs son," shouted the
criers, "let him come and tell."
This they repeated again and again, till at length a young man came
forward who had witnessed the accident.
"I was standing on a hill," he said, "and I saw the hunters, and I saw the
son of the chief. And when he was on level ground he disappeared, and I
saw him no more."
He led the men of the tribe to the spot, and they scattered to look for
signs of the youth. They found his trail; they followed it to the pit, and there
it stopped.
They pitched their tents round the chasm, and the chief begged his
people to descend into it to search for his son.
"If any man among you is brave and stout-hearted," he said, "let him
enter."
There was no response.
"If any one will go I will make him rich."
Still no one ventured to speak.
"If any one will go I will give him my daughter in marriage."
There was a stir among the braves and a youth came forward.
"I will go," he said simply.
Ropes of hide were made by willing hands, and secured to a skin shaped
to form a sort of bucket.
After arranging signals with the party at the mouth of the pit, the
adventurous searcher allowed himself to be lowered. Once fairly launched
in the Cimmerian depths his eyes became accustomed to the darkness, and
he saw first the buffalo, then the horse, then the young brave, quite dead. He

put the body of the chief's son into the skin bucket, and gave the signal for it
to be drawn up to the surface. But so great was the excitement that when his
comrades had drawn up the dead man they forgot about the living one still
in the pit, and hurried away.
Lost Underground
By and by the hero got tired of shouting, and wandered off into the
darkness.
He had not gone very far when he met an old woman. Respectfully
addressing her, he told her his story and begged her to aid his return to his
own country.
"Indeed I cannot help you," she said, "but if you will go to the house of
the wise man who lives round the corner you may get what you want."
Having followed the direction she had indicated with a withered finger,
the youth shortly arrived at a lodge. Hungry and weary, he knocked
somewhat impatiently. Receiving no answer, he knocked again, still more
loudly. This time there was a movement inside the lodge, and a woman
came to the door. She led him inside, where her husband sat dejectedly, not
even rising to greet the visitor. Sadly the woman told him that they were
mourning the death of their only son. At a word from his wife the husband
looked at the youth. Eagerly he rose and embraced him.
"You are like our lost child," said he. "Come and we will make you our
son."
The young brave then told him his story.
"We shall treat you as our child," said the Wise Man. "Whatever you
shall ask we will give you, even should you desire to leave us and to return
to your own people."

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Evolution Of Markets And Institutions A Study Of An Emerging Economy Routledge Studies In Development Economics 1st Edition Murali Patibandla

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Evolution Of Markets And Institutions A Study Of An Emerging Economy Routledge Studies In Development Economics 1st Edition Murali Patibandla

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